US inflation posts fresh 40-year high.

Markets were continuing to monitor Ukraine developments very closely with unease over US and UK warnings that Russia could use false flag warnings of Ukraine development of biological warfare programmes as a pretext to use chemical weapons.

On Thursday, the wider economic implications had a larger impact on financial markets with increased concerns over the outlook for inflation, especially with sustained upward pressure on food and energy prices.  Overall confidence in the global economic outlook deteriorated.

US consumer prices increased 0.8% for February, in line with consensus forecasts with the year-on-year rate increasing to 7.9% from 7.5%. This was also in line with expectations and the highest rate for 40 years.  Energy prices increased 25.6% over the year with a 43.6% surge in fuel oil while food prices increased 7.9% over the year.

Underlying prices increased 0.5% on the month with the annual rate also meeting expectations at 6.4% from 6.0%. There was a small decline in used vehicle prices for the month, but with a 41% annual increase while there was a strong increase in transport services for the month.

US Treasury Secretary Yellen warned that inflation would increase further in the short term. During Wednesday, there were sharp losses for US Treasuries with the 10-year yield increasing sharply to around 2.00%. Markets were extremely uneasy over the global inflation outlook which undermined support for fixed-income assets.

The ECB held interest rates at 0.0% following the latest council meeting. As planned, the central bank will end emergency bond purchases this month, but there was a change in the planned APP purchases with a faster taper for the second quarter. Third-quarter purchases will depend on market conditions at the time while the bank is then planning to stop purchases if the data indicates that the medium-term inflation outlook will not weaken. This was a significant and hawkish shift from the previous meeting.

The Euro spiked higher after the decision with the statement more hawkish than expected and markets brought forward their expected timing of a rate increase. Markets priced in 43 basis points of tightening by the end of 2022 from 30 basis points ahead of the meeting.

The central bank lowered its GDP growth forecasts for 2022 while the HICP inflation forecast was revised sharply higher to 5.1% from 3.2% previously.

President Lagarde stated that risks to the economic outlook are now tilted to the downside. The combination of lower growth and higher inflation forecasts sapped Euro confidence amid stagflation fears and the Euro declined surrendered gains.

The impact of higher bond yields was clearly illustrated in Asia on Friday with the yen under pressure. USD/JPY posted a 5-year high at 116.75 despite fragile global risk appetite.

There is likely to be significant caution on Friday with reservations over a potential escalation in the Ukraine conflict when markets are closed. Traders and funds are likely to be very wary over holding long positions in risk assets over the weekend.

The Euro spiked higher following the ECB policy announcement but was unable to sustain the gains. There were further fears over the Euro-zone outlook and threat of stagflation which sapped support. EUR/USD retreated quickly from highs above 1.1100 and traded around 1.1000 on Friday.

US bond yields moved significantly higher with the 10-year yield around 2.00%. USD/JPY struggled to gain much traction initially, but then posted a strong advance to 5-year highs around 116.75 on Friday.

Sterling was again hampered by fears over the UK outlook amid a squeeze on incomes. Stronger than expected January data provided slight relief. GBP/USD dipped to 16-month lows around 1.3070 before a tentative recovery. EUR/CHF was unable to hold intra-day highs and settled around 1.0230.

Commodity currencies posted renewed gains amid expectations of strong commodity earnings. AUD/USD posted net gains to 0.7350. The Canadian dollar secured limited net gains with USD/CAD around 1.2765.

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