European markets have opened positively this morning as Dutch elections resulted in impressive gains for Pro-European Liberal parties. While the right wing PVV party gained 5 seats and is now the second largest party in parliament on 20 seats, all of the other main parties have rejected the possibility of joining PVV in a coalition. Dutch bonds have rallied and the euro has broken through 1.07 against the dollar to trade to a 5 week high. European stock markets have also outperformed their peers, up over 1% already this morning as compared to a gain of 0.7% in the UK and 0.5% in the US. The focus in Europe now switches to the upcoming French presidential elections scheduled for the end of April and early May.
The Fed delivered on its widely anticipated rise of 25 basis points in official interest rates and also reaffirmed that their period of ultra-loose monetary policy is over, indicating that they will raise US rates twice more in 2017. Markets responded positively to the rate hike, relieved that the Federal Reserve left their expectations for interest rates and inflation in 2017 and 2018 largely unchanged from their previous update. The Fed Funds rate targets a band between 0.75% and 1% and the Fed’s dot plan expects this rate to reach 1.4% by the end of this calendar year.
The rate hike in the US was quickly followed by a rate hike from China in a move seen by markets as a bid to stop the Yuan from weakening and to prevent an outflow of capital. This highlights the second round effects that tightening in US policy has on currencies linked to the dollar or economies with a significant amount of US$ debt. Emerging market currencies rose after the Fed sounded a less hawkish tone but a more aggressive stance from the Fed poses risks for global risk assets. To this end, US inflation and expectations on rates will be a key driver for markets over the rest of the year.
Later today, the Bank of England meets. Despite the fact that inflation is rising and unemployment, at 4.7%, is at its joint lowest level since 1975 the market does not anticipate that the MPC will follow the Fed and PBOC in raising rates. In its most recent update, the BOE upgraded its forecasts for the UK economy but with political risk, highlighted by the Chancellor’s embarrassing national insurance budget u-turn, remaining elevated, it is unlikely that the committee will adjudge that the time is right to raise the base rate. Sterling and term interest rates will be quiet into the meeting but any change in voting or sentiment will see some volatility in the currency this afternoon.