Rate setters give markets pause for thought

Ahead of this month’s Fed and MPC interest rate setting meetings, the narrative had been one of markets preparing for a historic divergence in monetary policy between the US and UK. Sterling had been on a renewed leg down against the dollar and US Treasuries were selling off relative to gilts, which saw the spread between 10-year yields reach a thirty-three-year high. But the ground those trends had made since the beginning of March was reversed in the days surrounding the central bank meetings. The Fed hiked rates as expected. But the limited change to board participants’ projected pace of tightening over the remainder of the year proved a dovish surprise. The MPC then surprised the other way, with Kristen Forbes splitting away from the pack with a vote for a hike, while for some other members, it would reportedly take “relatively little further upside news on the prospects for activity or inflation for them to consider…a more immediate reduction in policy support.” Nonetheless, significant policy divergence is still on the cards. Slowing consumer spending in the UK will see growth ease and domestic inflationary pressure remain muted this year, allowing the MPC to stand pat. In contrast, rising inflation is likely to force the Fed to tighten faster than markets expect.