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The sun still continues to rise, which based on the general reaction to the outcome of the UK referendum on 23 June is quite a relief. In fact, it is almost starting to feel like business as usual. Businesses seem to be adapting to the new reality and making plans based on a triggering of Article 50 by the UK, anticipated by the end of the year. There is continued uncertainty about what this will mean. The European Central Bank (ECB) and the Bank of England (BoE) have both taken the view that there is not enough information at this stage to make any changes to monetary policy. The Federal Reserve also kept rates at the same level at their meeting yesterday, however it signalled that the immediate worries that had been of concern at the June meeting have abated.
Prior to the ECB’s meeting last week – where it was announced that key rates remain unchanged and the asset purchase programme is set to continue until March 2017 (and beyond if necessary) – there was concern about the scarcity of bonds available for the bank to purchase. A flight to safety, and the bank’s restriction on the minimum yield that they would tolerate, meant that the pool of bonds available for purchase was significantly reduced. Mario Draghi was quizzed on this during the post-ECB meeting press conference last Thursday. His response was clear: “…we discussed the general economic conditions and we concluded that we didn't have yet information to take decisions [to change policy]”. The next significant data release in Europe will be inflation figures on Friday, and it will be interesting to see if they have followed the UK with higher than expected inflation for Q2.
The BoE took a similar stance on 13 July by holding rates and unanimously agreeing to maintain the QE program at £375bn. In the bank’s press release they commented on the measures of sentiment amongst households and companies, saying there had been sharp falls in consumer confidence which were likely to have a weakening impact on the economy in the near term. The bank reiterated that it would take whatever action necessary to support growth and return to the target inflation level. Most members of the committee expect monetary policy to be loosened in August, with one member voting for a 25 basis point cut in the rate at the July meeting.
The Federal Reserve has a different situation on its hands. Given the data on the US economy, the challenge here is maintaining the momentum towards normalisation of interest rates. The question is, when will the next step be taken? The meeting schedule for the Fed is September, November and December, giving three opportunities for a rise this year. The message from the latest meeting left the door open for a rise in September; however, with the Presidential election in November, it seems more likely to be December before they move. More information will likely be provided at the annual Jackson Hole meeting of central bankers in August.
The action of the central banks should be considered in the broader context of the current market swap rates. The GBP five year swap rate is approximately 50bps lower than on 22 June, currently at 43bps, and has shown no sign of recovery. The five year euro rate initially fell to -34bps (from -16bps) and has recovered slightly to -28bps. The USD five year swap rate initially fell by approximately 30bps (from 1.2%) and has now recovered to approximately 1.13%. Combining this information with the downward sloping nature of the GBP LIBOR curve, the market is expecting action from the BoE.
As the future becomes clearer and the shape and timing of the UK’s exit from the EU becomes more defined, there will be significant moves in both the interest rate and the currency market. Whilst the medium-term expectation for base rates in the UK and Europe is to remain low and possibly even go lower, this is not the case for the US. The sun will continue to rise, however there is undoubtedly more turbulence ahead.
All views expressed here are the author’s own and are based on information available at the time of writing.
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