Sterling falls as BoE expects recession, U.S. futures up

By Huw Jones

LONDON (Reuters) - Sterling fell on Thursday after the Bank of England followed its counterparts in the United States and euro zone with a hefty hike in interest rates to quell inflation, saying Britain faces a lengthy recession.

As widely expected, the BoE increased rates by 50 basis points to 1.75%, its sixth increase since December but the biggest since 1995.

The UK economy would begin to shrink in the final quarter of 2022 and contract throughout next year, making it the longest recession since after the global financial crisis, the central bank said.

"The main surprise seems to be the somewhat downbeat economic forecasts that we have also been given, which are showing a recession expected in Q4 and lasting through 2023," said Stuart Cole, head macro economist at Equiti Capital.

"That is somewhat worse than what we had seen in May, where the outlook was for one or two difficult quarters of low or negative growth, and then a recovery."

Sterling was down 0.2% at $1.2122 after being slightly firmer ahead of the BoE announcement.

British gilt yields fell sharply, with euro zone bond yields extending their fall after the BoE statement.

S&P 500 futures were firmer ahead of Wall Street's open and the latest jobless claims data, though Friday's non-farm payrolls will be more closely watched.

Stocks were steadier overall on Thursday, helped by strong earnings in Europe while Asian shares recovered some of Wednesday's losses driven by tension over Nancy Pelosi's visit to Taiwan.

The STOXX index of leading European companies gained 0.5%, helped by German airline Lufthansa returning to an operating profit, and strong earnings from commodities giant Glencore (OTC:GLNCY). French bank Credit Agricole (OTC:CRARY) joined the growing roster of better-than-expected earnings at banks.

Shares in Hong Kong rose 2%, tracking broader gains in Asia, reeling in some of the losses suffered after Sino-U.S. frictions flared over a visit to Taipei this week by House of Representatives Speaker Pelosi, which angered China.

Oil prices stabilised after hitting six-month lows, while the dollar was underpinned by U.S. Federal Reserve officials pushing back against suggestions they will slow the pace of interest rate hikes, with one saying a 50 basis point hike would be "reasonable". A survey from the European Central Bank showed that consumers in the euro zone are bracing for the economy to shrink and for high inflation to continue.

NO EARNINGS RESET YET

Kasper Elmgreen, head of equities at asset manager Amundi, said the illusion that decades-high inflation would be transitory was now firmly gone as fuel bills surge and companies have difficulties finding staff.

"The big picture here is that it's going to require quite a lot to restore price stability. The risk here is that we underestimate how powerful a force it is we are dealing with," Elmgreen said.

The second quarter earnings season now underway has not provided a major "reset" to what Elmgreen sees as still too high earnings expectations for 2022 overall given the economy is slowing.

"I think that might come in the third quarter or fourth quarter as we start to see more demand impact," Elmgreen said.

Fed officials have provided a hawkish chorus this week, battering the short end of the yield curve. Two-year Treasury yields were trading at 3.0938%, down slightly, while the benchmark 10-year year yields traded at 2.7209%, also slightly weaker.

The dollar has halted a decline that began in the middle of July, with support from both rate hike expectations and heightened political tension. [FRX/]

Fed funds futures remain priced for rate cuts to be under way by the middle of next year and the inversion of the U.S. yield curve, with 10-year yields below two-year yields, suggests investors think that the hiking path will hurt growth.

The dollar index was trading at 106.27, down 0.178%. A euro weighed by Europe's energy crisis bought $1.0188.

Brent crude futures were slightly firmer at $96.82 a barrel as supply concerns triggered a rebound from multi-month lows on Wednesday after U.S. data signalled weak fuel demand.

Spot gold rose 0.9% to $1,781 an ounce.