Bank of England votes to raise interest rate to 5%

At its latest policy decision, the Bank of England (BoE) Monetary Policy Committee (MPC) voted to raise interest rates by 50 basis points to 5.00%, exceeding the consensus forecast of a 25 basis-point hike to 4.75%. Speculation of a higher increase had intensified following Wednesday's unexpectedly high inflation data. The decision was supported by a 7-2 vote, with Tenreyo and Dhingra favoring unchanged rates at 4.50%. Initially, the British Pound (GBP) experienced a surge but later retreated. The GBP/USD exchange rate spiked to 1.2840 before falling to 1.2750, while the GBP/EUR settled around 1.1610 within a range of 1.1580-1.1665. Traders in future markets adjusted their expectations, fully pricing in a rate hike in August and anticipating peak rates of at least 6.0%. Shorter-term gilts faced losses, leading to a net gain in the 2-year yield at approximately 5.07%, while longer-term yields decreased. Equities also declined, with the FTSE 100 index closing 1.2% lower on the day and reaching a three-week low.

The committee highlighted the significant positive news in recent data, indicating a more persistent inflationary trend due to a tight labor market and resilient demand. The bank also noted higher bond yields and a slight strengthening in indicators of household spending. However, concerns were expressed regarding inflation expectations, as medium-term inflation compensation measures in financial markets had risen above their average levels of the previous decade since the MPC's previous meeting.

The majority of the committee acknowledged that some indicators of future wage growth and goods inflation had weakened. However, these indicators had not been tested as leading indicators during a period of high inflation. The substantial upside surprises in official estimates of wage growth and services CPI inflation suggested the need for a 0.5 percentage point interest rate increase at this particular meeting.

Governor Bailey emphasized the necessity of slowing the rate of wage settlements and the urgency for the bank to act now to mitigate the risk of requiring even larger rate increases in the future. The MPC committed to closely monitoring persistent inflationary pressures, including labor market conditions, wage growth, and services price inflation. If evidence of continued pressures emerges, further tightening of monetary policy would be necessary.

Following the retail sales data for May, the reaction of Pound Sterling against the Euro and US Dollar was mixed. The report indicated a second consecutive monthly rise in retail sales, with a 0.3% increase in total sales volume, including fuel, following a 0.5% rise in April. Favorable weather conditions boosted online purchases of outdoor goods and clothing, while lower fuel prices contributed to increased sales as well.

Euro slumps after poor European PMI data

Early on Friday, EUR/USD faced significant bearish pressure, breaking below 1.0900. The Euro was weighed down by disappointing PMI surveys from Germany, France, and the Eurozone, while the US Dollar continued to strengthen due to risk aversion.

The pair experienced renewed bearish pressure after Thursday's decline and breached the 1.0900 level. If buyers fail to defend 1.0870, further losses could occur before the weekend.

FOMC Chairman Jerome Powell's hawkish comments during the second day of his congressional testimony, coupled with the risk-averse market sentiment, bolstered the US Dollar's performance on Thursday. Following a quiet Asian session, the pair resumed its downward movement as concerns over a recession in the Euro area grew, reaching its lowest level in a week near 1.0850.

Data from Germany and the Eurozone revealed a continued contraction in business activity in the manufacturing sector in early June, with the German Manufacturing PMI dropping to 41 and the Eurozone Manufacturing PMI to 43.6. Although the Services PMIs for both regions remained above 50, indicating expansion, they significantly declined from May levels.

According to Reuters calculations, the probability of a 4.25% terminal rate for the European Central Bank (ECB), which stood at 15%, virtually dropped to 0% following the PMI readings.

Heading into the weekend, market focus will be on S&P Global's release of Manufacturing and Services PMI data for the US. If there is an unexpected rebound in the Services PMI, it is likely to support the strength of the US Dollar. Conversely, a significant decline in the data could have the opposite effect on the valuation of the US Dollar.

Market participants will also closely monitor the perception of risk. US stock index futures are down by 0.3% to 0.5%. Even if disappointing PMIs weigh on the US Dollar, a bearish reaction in the major indexes of Wall Street could impede any potential rebound for EUR/USD.

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