ECB holds rates, warns of inflation risks
A continuing rise in global energy prices contributed to higher bond yields, weaker equity markets – with AI-related concerns also weighing on stocks – and a firmer dollar. The ECB left interest rates unchanged, as expected, but warned of upside risks to the inflation outlook, keeping intact market expectations that it will most probably hike rates at its next meeting in September and again before the end of the year. The euro has weakened to under $1.14 against the dollar, leaving it not much more than half a cent above its 2026-to-date lows of around $1.1325 reached in June. Sterling has lost ground to both the dollar and the euro, trading at circa $1.3340 and £0.8545 respectively (the latter off levels of around £0.8450 a week ago), albeit stronger than expected UK retail sales data released a short while ago are providing some support for the pound this morning.
With oil prices climbing to over $100 per barrel (in the case of Brent), government bond yields continued to head north, rising by 3-7bps in the main markets, with the short-end of curves tending to see the biggest increase in yields amid a firming of expectations for central bank rate hikes. Looking out to the middle of next year, around 70bps of hikes are now priced in for both the ECB and Bank of England, and around 60bps for the Fed, some 10-15bps more than was the case at the end of last week. Equity markets sold off quite a bit yesterday, shedding 1-2% on the day, with higher energy prices and AI concerns weighing on stocks.
As expected, the ECB left interest rates unchanged following yesterday’s meeting. It noted that “uncertainty remains high and the full inflationary impact of the energy shock has yet to play out,” and said it is “closely monitoring the intensity and duration of the shock, as well as its indirect and second-round effects”. Christine Lagarde revealed that some members “asked whether we should not consider a hike today (but) we all unanimously decided that we were positioned adequately to wait and be very attentive in the next few weeks to the development of the situation and to the data that we will be receiving in the next few weeks” (ahead of the next meeting in September).
Retail sales volumes in the UK rose by 1.0% in June, following an increase of 1.2% in May, with “promotions and the warm weather” boosting spending in the month. For Q2 as a whole, retail sales grew by 0.6%, easing from growth of almost 1.5% in the first quarter of the year.
Looking to the day ahead, economic data due include flash PMIs for July in the main economies (Euro area, UK, and US) and new home sales in the US, while the ECB releases its June survey of consumers short- and medium term inflation expectations.