How Will The Markets React?
With oil and other commodity prices rocketing to record highs, there are well-warranted concerns that global inflation will rise significantly. The prospect of increased price pressures only compounds the problems that the Bank of England already faces as they contend with mounting downside risks to growth and uncertainty surrounding the ongoing reappraisal of risk in the financial markets. Nevertheless, Bank of England Governor Mervyn King and his monetary policy committee took a bold step and unexpectedly cut rates by 25bp on December 6, as credit market conditions remain uncomfortably tight. However, King – an ardent inflation hawk that is strongly against increasing the risk of moral hazard – probably was not actually in favor of a cut, as more accommodative monetary policy would only fan price pressures, and he was likely outvoted by others in the committee. The inflation issue may come to the forefront once again on Monday as UK input and output costs are forecasted to rise strongly. Indeed, PPI input is expected to surge 9.3 percent from a year ago while PPI output is predicted to gain 4.2 percent from a year ago – the sharpest rise in twelve years. The data not only suggests that broad price pressures are mounting, but also that companies are feeling the squeeze on their profit margins as they are unable to pass through the increased costs to their customers. Furthermore, the news will set the stage for the release of CPI on December 18, which is anticipated to show that consumer price growth accelerated faster than the Bank of England’s 2.0 percent target once again and could prevent the central bank from cutting rates in January.
The Bank of England cut rates recently, will the Federal Reserve? Discuss the topic in the DailyFX Fed Watch Forum.
Bonds – 10-Year Long Gilt Futures
Gilts gave back all of Thursday’s gains following the BOE rate cut to target support near the 109.77 level amidst stock market rallies. Intraday technicals suggest further weakness, but near-term support appears to be holding up well. Nevertheless, Monday’s UK data could spark additional losses as PPI is forecasted to rocket higher, putting the focus back on upside inflation risks and raising speculation that the BOE will not move to cut again in January.
FX – GBP/USD
Speculation about the Bank of England’s rate decision last Thursday led Cable to plummet over the course of the week. However, the actual rate announcement – a 25bp cut – saw relatively lackluster reaction in the pair and the British pound has only climbed since the decision hit the wires. Indeed, an ascending trendline at 2.02 serves as critical support for GBP/USD and the bounce suggests more bullish price action in the near-term. Immediate resistance looms at 2.0330, and a break above there targets 2.0425. While Friday’s price action could change the picture for the pair given the US event risk on hand (NFPs), Cable may be supported on Monday by UK PPI figures, as they are likely to remind the markets that upside inflation risks remain a threat to the economy. On the other hand, softer than expected readings would support the case for additional rate cut by the BOE, and could pus GBP/USD down for another test of 2.02, with extremely sharp declines targeting 2.00.
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Equities – FTSE 100 Index
The FTSE 100 has run into resistance at the 6,600 level, temporarily cooling a stock market rally spark by the BOE’s surprise rate cut. Nevertheless, the same conditions still remain an issue: credit markets are tight, downside risks to growth are mounting, and upside inflation risks persist. On Monday, UK PPI figures could help the FTSE 100 pull back towards support near 6,400, as they are anticipated to highlight price pressures in the pipeline, which could prevent the BOE from cutting rates again in January. On the other hand, an extremely weak figure will only lead traders to keep betting on more rate cut relief, and the sentiment could push the index to break through resistance to target the highs at 6,754.10.