The political chaos in Westminster, uncertainty over the UK’s economic outlook and ongoing Brexit concerns should encourage the Bank of England to “stand pat” on rates in Thursday’s MPC meeting. With the central bank highly unlikely to make any changes to monetary policy amid the instability, investors will most likely direct their attention towards Mark Carney for insights on how he plans to tackle the various challenges that the UK political climate and Brexit developments have presented.
While inflation in the UK has hit a four-year high at 2.9%, wage growth remains subdued and this creates further headaches for the BoE. Although raising interest rates to cool inflation is seen as a practical strategy, it may simply end up pressuring borrowers ultimately eroding business confidence and pinching consumers further.
Prior to the anticipated BoE meeting, the British Pound was vulnerable to heavy losses following the disappointing 1.2% decline in UK retail sales in May which fueled fears of Brexit negatively impacting the UK economy. UK retail sales have plunged for the second time in three months as rising inflation diminishes the purchasing power of consumers. With wage growth struggling to keep up with inflation, concerns may mount over the sustainability of the UK’s consumer-driven economic growth.
Fundamentally, Sterling remains gripped by political uncertainty while ongoing Brexit woes have obstructed upside gains. With recent economic data following a negative trajectory, Sterling bears could be instilled with enough inspiration to send the British pound/U.S. dollar (GBP/USD) currency pair towards 1.2600.
Yellen dishes out hawkish surprise
Financial markets were caught completely off guard during late trading on Wednesday after the Federal Reserve adopted a firmly hawkish stance and even displayed some optimism over economic growth despite mounting concerns over weak inflation. The tone of caution investors were anticipating from the Fed was replaced by a strong determination to continue tightening in response to falling employment while accepting the prolonged periods of weak inflation this year. Although the hawkish surprise offered a temporary boost to the dollar, markets have not bought into this newfound optimism as expectations of another interest rate increase in 2017 currently stands below 50%.
With the recent economic developments in the U.S. encouraging FOMC members to trim their medium estimates for inflation to 1.6% this year, the central bank may be in no rush to hike rates again in the coming months. It should be kept in mind that U.S. consumer prices unexpectedly declined in May and retail sales recorded their biggest drop in 16 months which questions whether the Federal Reserve has become excessively hawkish. While the Fed has repeatedly stated that this period of economic softness is “transitory” this will be put to the test in the coming months as participants heavily scrutinize economic data.
The central bank also shared details about how it would reduce its massive $4.5 trillion balance sheet this year which complimented the hawkish rhetoric.
All in all, there seems to be a disconnect between what the markets anticipate and what the Fed is signaling with investors needing more persuasion on the Federal Reserve’s ability to raise rates again. This persuasion could be in the form of improving economic data but until then, the dollar Index remains under pressure on the daily charts with further weakness opening a path towards 96.50.
Oil markets drowned by oversupply fears
WTI crude was exposed to heavy losses on Wednesday with selling activity invading Thursday's trading session after an unexpectedly large build in gasoline inventories fuelled oversupply fears. It is becoming quite clear that despite OPEC’s valiant efforts to rebalance the saturated markets by trimming output, the global glut continues and has left oil trading at depressed levels.
With the bearish price action on WTI crude suggesting that those who were heavily bullish on the commodity may be having second thoughts, the upside may be limited. I believe sentiment towards oil remains heavily bearish and further losses should be expected as oversupply concerns inspire sellers to attack the commodity ruthlessly.