The Bank of England sent shockwaves through world financial markets, as they unexpectedly raised UK interest rates by 25 basis points for the third time… … since August, 2006.

Ramifications of their decision became immediately obvious, as the
British Pound instantaneously set 7-month highs against the Euro, while a spike in
volatility left bond and equity markets significantly lower. All 52 analysts polled
by the Bloomberg News Service predicted that the bank would leave the central rate
at 5.00 percent for the second consecutive meeting, but officials clearly defied
consensus sentiment and opted to tighten monetary policy yet again. In fact, the
Monetary Policy Committee showed little sign of slowing its tightening pace—citing
risks that inflation may accelerate more than previously forecast. This hawkish
sentiment pushed futures traders to price in a further 50 basis points of interest
rate hikes through the second quarter, which would leave the headline rate just
0.25% short of 8-year highs. Such expectations clearly bode well for the domestic
currency, but bond prices may continue to drop if the BoE does not relent in its
definitively hawkish stance on inflation.

Bonds – UK 10-Year Gilt

UK fixed income markets saw sizeable declines through todays trade, with the
2-year Gilt yield adding an impressive 14 basis points in yield to 5.36 percent
through the close. Price action was significantly more subdued in longer term debt,
however, with the 10-year Gilt yield posting a more modest 5 basis point gain.
Traders showed clear dismay with the interest rate change, but cooler heads
prevailed as the long-term outlook remained little moved. What remains to be seen is
whether such a retrace will prove sustainable, with a clearly hawkish central bank
bias leaving risks to the upside for interest rates through the medium term. Rising
yields (both long and short) could only further boost the UK currency, which already
enjoys interest rates at parity with its US counterpart.

FX – GBPUSD

Forex traders showed no hesitation after the Monetary Policy Committees
unexpected rate hike this month. With another 25 basis tacked onto the UKs
already sizable overnight lending rate, the British pound is now equipped with a
5.25 percent interest. This is a significant level in the currency market as it
matches the dollars rate, achieved after two years of non-stop tightening. This
is yet another boost to pairs that are well obvious carry traders. On this note,
GBPJPY, GBPCHF and EURGBP all took-off in favor of the pound. Even those pairs that
are not clearly carry pairs were swept up in the wave of bids. Perhaps one of the
most obscure pair now, the GBPUSD, essentially gapped in the moments it took for the
announcement to run across the ticker and traders to execute their orders. With the
rush in market orders, the 11:59 candle closed at 1.9382 and the next minute closed
on a print of 1.9517. Few outside the big bank dealers directly wired into the
interbank likely found execution within this sizable move, which was evident by the
stalling price action only two minutes after the release. With so many stops
completely blown through and those already long the pair prior to the release, it
only took a few second before a 60-point retracement took over. The daze this
massive move impressed on the market slowly wore off though as the day wore on and
traders dealt with the implications of a virtual wash for a carry. From the short
statement that followed the BoEs decision, it was obvious that the risks in
inflation were still to the upside. This has been reflected in short-term interest
rate futures through the pricing in of another quarter percent rate hike expected by
the end of the quarter. Nevertheless, with the economy in a holding pattern at
three-year low, the UK outlook looked like the inflection of the US, whereby the
pricing in of a rate shift is heavily pushed by aggressive speculation. With this in
mind, longs began to take profit and in close the gap. By the end of the New York
session, the GBPUSD was only 60 points away from the levels traded before the
announcement a modest day for the pair.

Equities – FTSE 100 Index

A rate hike is a heavy burden for a business as it can incur many thousands or even
millions of additional fees in debt payments. With the drain on revenue in mind, UK
stocks entered a steep decent. In fact, in the first few minutes following the
release, the benchmark FTSE 100 Index plunged 0.7 percent. After a few failed
attempts to restart the bullish momentum from Wednesdays session, the index went
on to mark a low 1.0 percent off of levels seen only two hours before at 6,130.20.
However, with UK and global equities fixed in such a strong uptrend, bears were in
short supply. Once the bottom was in place, investors saw an opportunity to buy on a
dip. In a performance not seen in some time, the FTSE 100 took off on a 1.7 percent
rally from its intra-day trough. Looking at a sample of some of the strong
performances across the market, the steep incline was as broadly based as the
initial drop following the BoE announcement. BHP Billiton and Rio Tinto shares led
the mining sector, HMV group represented the consumer goods industry and HBOS Plc
came in for financials. Proving the strength of the run, the benchmark index
finished the day only without a single red bar in the preceding four-and-half hours.
This suggests a strong open for the final session of the week; and perhaps a strong
advance for some time to come.

Regards,

John Kicklighter
Forex Capital Markets
32 Old Slip, 10th Fl
New York, NY 10005
Email: jkicklighter@dailyfx.com

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