European stocks rally as central banks toughen stance on inflation

European markets held on to strong gains on Thursday after the Bank of England followed the Federal Reserve in assuming a more aggressive stance in pushing back against high levels of inflation.

London’s FTSE 100 index maintained its early morning gains following the BoE’s decision, rising 1 per cent. Sterling climbed 0.8 per cent against the dollar to $1.337, its strongest level in three weeks. Markets on continental Europe were up more strongly, pushing the regional Stoxx 600 up 1.7 per cent, while US stock-index futures also advanced.

The BoE’s Monetary Policy Committee voted 8-1 on Thursday to increase rates by 0.15 percentage points to 0.25 per cent, surprising some economists who had expected the BoE to hold fire given the rapid spread of the Omicron coronavirus variant.

Investors sold UK government bonds following the BoE decision, pushing the 10-year gilt yield up 0.08 percentage points to a two-week high of 0.81 per cent. The selling also spilled into eurozone debt, with Germany’s 10-year yield rising 0.04 percentage points to minus 0.33 per cent.

Policymakers at the European Central Bank also on Thursday confirmed plans to end net purchases under the central bank’s pandemic-era bond-buying programme next March. However, in the second quarter of next year, the ECB will increase the rate of bond purchases under another scheme by €20bn to €40bn, before tapering it back to €20bn starting in October 2022.

Thursday’s policy decisions came a day after the Fed, the world’s most influential central bank, announced that it would speed up the rate at which its huge pandemic-era stimulus programme was wound down, with bond purchases now set to end in March rather than June.

Central bank officials also signalled in their economic outlook that they plan to raise interest rates three times next year, marking an escalation in efforts to restrain price growth. The measures, said Fed chair Jay Powell, were necessary to tackle what he described as “elevated levels of inflation”.

Higher prices, Powell said, were the result of “supply and demand imbalances related to the pandemic and the reopening of the economy”, adding that the problems had been “larger and longer-lasting than anticipated, exacerbated by waves of the virus”.

Yet despite its more hawkish interest rate forecasts, US markets rose sharply in the hours following the central bank’s statement, with the benchmark S&P 500 closing at its second-highest level on record and the technology-heavy Nasdaq trading up 2.2 per cent for the day. S&P 500 futures gained about 0.7 per cent on Thursday morning in Chicago.

“As Powell spoke he seemed to get a little more confident in the economy and get a little more hawkish than expected,” said Steve Bartolini, portfolio manager at T Rowe Price. “But given the market reaction, he was not as hawkish as feared.”

Powell, meanwhile, struck a positive tone on growth, arguing that economic activity was “on track to expand at a robust pace this year”.

Although the emergence of Omicron poses a risk to that outlook, Ron Temple, head of US equities and co-head of multi-strategy at Lazard Asset Management, said Powell had sent “a signal that this is an economy that is still firing on all cylinders”.

“There is a lot of consumer demand despite the Delta wave, despite the Omicron fears,” he said. “And I think [the Fed] struck exactly the right balance. And maybe that is why the market is responding the way it is.”

Additional reporting by Eric Platt and Kate Duguid in New York