The British pound has ticked higher in the Thursday session. In North American trade, GBP/USD is trading at 1.2760. On the release front, the BoE maintained rates at 0.25%, but surprised the markets as three MPC members voted in favor of a rate hike. Retail Sales declined 1.2%, missing the forecast of -0.9%. Over in the US, unemployment claims dipped to 237 thousand, marking a 3-week low. On the manufacturing front, the news was mixed. The Empire State Manufacturing Index rebounded with a strong gain of 19.8, crushing the estimate of 5.2 points. The Philly Fed Manufacturing Index dropped sharply to 27.6, but still beat the estimate of 25.5 points.
British inflation levels continue to rise, and this has hurt the purchasing power of UK consumers. This was evident in the May retail sales report, which sagged badly, dropping from +2.3 percent to -1.2 percent. The weak reading was worse than expected, as the forecast stood at -0.9 percent. With inflation up and the pound and wages down, the UK consumer is understandably in a surly mood about lower living standards, and this sentiment may have played a key role in last week’s election, which saw Prime Minister May humiliated, as she lost her majority in parliament. There are hopeful signs that the political turmoil which has rocked the country could end soon, with reports that May’s Conservatives and the DUP, a small Irish party, have reached an agreement in principal, which would enable May to continue to govern. May’s minority government may prove to be unstable, and she will go into the Brexit negotiations with a much weaker hand than prior to the election. This new set of circumstances may force a chastened May to be more flexible, and agree to a "soft Brexit", which would see the UK remain in a single market, in return for allowing free movement from the continent into Britain.
After preparing the markets with plenty of broad hints, the Federal Reserve pressed the rate trigger at its June meeting, marking its second rate hike in 2017 . The Fed increased rates by 25 basis points, to a target range of 1.00 percent to 1.25 percent. Janet Yellen & Co. appear sanguine about the US economy, and this optimism was reflected in a rate statement that was more hawkish than expected. The statement portrayed an optimistic picture, noting that the economy was growing and the labor market remained strong. Policymakers appear unfazed over stubbornly low inflation, as the statement noted that although inflation remains below the Fed’s target of 2.0%, it expected that target to be reached in the "medium term". The Fed projected one more rate hike in 2017, and the markets are circling the December meeting as the most likely date. However, the markets don’t seem to share the Fed’s optimism as far as another rate hike this year. The odds for a September increase are at 18%, compared to 23% a week ago, according to the CME Group. As for a December increase, the odds stand at just 38%. One surprising development was that Fed Chair Janet Yellen outlined a plan to reduce its $4.2 trillion balance sheet (comprised of Treasury bonds and mortgage-backed securities). Yellen was short on specifics, saying that the goal was to begin the normalization "relatively soon". The balance sheet ballooned after the financial crisis in 2008, as the Fed implemented a massive quantitative easing program as part of its accommodative monetary policy, together with interest rates of zero. The gradual reduction in the purchase of these assets signifies an important vote of confidence in the strength of the US economy.
