The European Central Bank on Thursday increased its benchmark interest rate by 25 basis points as it continues to fight a surge in consumer prices, with rates now at levels not seen since November 2008.

The decision comes after inflation figures released earlier this week showed an increase in the headline rate to 7% for April. At the same time, core inflation, which excludes food and energy prices, decreased slightly to 5.6%. "Headline inflation has declined over recent months, but underlying price pressures remain strong," the central bank said Thursday.

The ECB embarked on its current hiking path in July 2022, when it brought its main rate from -0.5% to zero. However, despite consistent rate increases since, inflation remains well above the ECB's target of 2%. Estimates published last week by the International Monetary Fund suggest that inflation will not reach the ECB's target until 2025.

Recent data also shows that the euro zone economy grew less than expected in the first quarter of the year, registering an anaemic GDP of 0.1%. However, unemployment numbers showed a slight improvement in March from the previous month at 6.5%.

Furthermore, a recent ECB survey showed that banks have significantly tightened access to credit, which could suggest that higher interest rates have started to take its toll on the real economy.

Across the pond, the Federal Reserve unanimously voted to increase interest rates for the tenth consecutive time, in keeping with their monetary tightening policy. This move has officially brought US interest rates into the 5% to 5.25% range, marking their highest point since August 2007.

The decision of the May meeting was closely watched, as analysts and experts alike believed it would be the final interest rate hike. Fed chairman Jerome Powell stated that no decision on a pause had been made, but investors noted the softer language used in the Fed's statement regarding future rate hikes. The statement read, "the Committee anticipates that some additional policy firming may be appropriate."

The Fed's decision on interest rates in the June meeting may be influenced by incoming data on jobs, the consumer price index, and inflation. However, Powell indicated that the Fed is unlikely to introduce any rate cuts in 2023 as inflation is expected to take some time to stabilize.

As we approach important central bank meetings and analyze the prospects for monetary policy, market volatility remains high. Analysts are focusing on whether interest rates will peak and if the ongoing historic tightening cycle is coming to a close.

The Bank of England is expected to raise rates by 0.25% in May, following recent economic data. However, there is much debate on whether this will be the peak or if further tightening will be necessary in the coming months due to conflicting signals from the underlying economy.

In the US, the central bank is expected to hike rates one last time this week before cutting rates later this year. This change in focus from inflation to recession is expected.

The European Central Bank is also likely to raise rates at this week's meeting, although analysts are divided on whether it will be a 0.25% or 0.50% move. Recent comments from officials indicate that the committee is becoming more divided.

On the exchanges, the US dollar remains weak due to concerns about the banking system and the US debt ceiling as the Fed reaches peak interest rates. GBP/USD is trading near its recent highs at the significant 1.2500 level, while GBP/EUR is trading near its monthly lows, reflecting a generally stronger Euro.

Following last week's economic data, market analysts are anticipating further rate hikes from the Bank of England. A 0.25% increase in rates is fully expected in May, with the projected peak now raised to nearly 5% later this year, which is likely to have a negative impact on UK market sentiment.

Inflation remains a concern, with headline inflation disappointing at 10.1%, and average earnings higher than expected at 5.9% or 6.6% excluding bonuses. This has contributed to the ongoing squeeze on disposable income.

Last week's retail sales figures showed a year-on-year drop of 3.1%. Meanwhile, in the US, the Fed is also expected to raise rates by 0.25% next month, with the consensus view being that this would be the peak, and rate cuts may be needed later this year as the focus shifts from inflation to growth.

The European Central Bank is currently the most hawkish, having started the tightening cycle later and from a lower base. Further rate increases are expected in the coming months as the bank remains fully focused on the challenging inflationary outlook.

Although sterling has been the best performing G10 currency this year, concerns about the UK economic outlook have overshadowed the repricing of UK rate hikes this week. GBP/USD remains close to its recent highs towards 1.2500, largely driven by a weaker dollar with US interest rates expected to peak first.

With a relatively quiet data calendar this week, the upcoming central bank meetings will be the main focus.

According to official data released on Wednesday, Britain was the only country in Western Europe to experience double-digit inflation in March, as it fell less than expected. The Office for National Statistics (ONS) reported that consumer price inflation (CPI) dropped to an annual rate of 10.1%, down from 10.4% in February, but still well above the economists' forecast of 9.8% and the Bank of England's (BoE) prediction of 9.2% in February.

The persistently high inflation, which reached a 41-year peak of 11.1% in October, is eroding the purchasing power of workers whose salaries are rising at a slower pace. In March, prices for food and non-alcoholic beverages were 19.1% higher than a year ago, the largest such increase since August 1977, due to higher costs of biscuits, cakes, milk, sugar, and to a lesser extent, chocolate and fruit.

The data highlighted concerns that Britain could experience prolonged inflation compared to its counterparts due to its dependence on natural gas for energy and electricity, as well as the structure of government subsidies that smoothed out price fluctuations.

Furthermore, the Bank of England is apprehensive that persistent inflation could trigger long-term wage demands and businesses' pricing strategies, further compounded by a decline in the labor force after the pandemic and trade and labor market frictions caused by Brexit.

Although core inflation, which excludes volatile food and energy prices, was expected to fall, it remained unchanged at 6.2%. Similarly, services inflation, which the BoE considers a proxy for domestic price pressures, also remained constant at 6.6%. As a result, the data strengthened expectations that the Bank of England would raise interest rates again in May.