Week ending 4th February 2022.

Whilst last week was all about the US Fed and its hawkish comments on interest rates, this week was all about the BoE and ECB.

And it was obvious that Fed policymakers aren’t the only ones who have changed their tune over inflation: in the UK, the BoE increased interest rates by 0.25% to 0.5%, while the European Central Bank said risks to the inflation outlook are on the upside, prompting financial markets to immediately start pricing-in higher Eurozone interest rates this year.

However, what we found bizarre was the shift in the BoE’s views: having been reluctant to increase UK interest rates as recently as last November, the BoE has since not only increased interest rates at the last two consecutive meetings, but this week came very close to increasing interest rates by 0.5% as four of the nine BoE policymakers actually voted for a larger increase!

And this mind-blowing about-turn suggests that not only will the BoE increase UK interest rates again at their next meeting on 17 March 2022, but it may also encourage Fed policymakers to kick-off their tightening cycle with a 0.5% increase when they meet on 16 March 2022.

Given this very loud and clear message from policymakers at the world’s major central banks, financial markets are now expecting (and therefore have already priced-in) a significant increase in interest rates over the coming months: for example, in the UK, interest rates are now expected to be 1% higher at 1.5% by September, while the Fed is now expected to make five increases during the year, starting with a 0.5% increase in March.

While we appreciate faster inflation may justify some increase in interest rates, we believe that current market expectations aren’t just very aggressive, but are actually way over the top.

As we have previously stated in these commentaries, much of today’s inflation is artificial in that it has been caused by a spike in energy prices and coronavirus induced supply-chain disruptions/bottlenecks which central bank policymakers are powerless to affect.

Additionally, economic growth is starting to slow as higher energy prices act in a similar way to a tax increase or higher interest rates, in that it squeezes our disposable income – and consumer spending accounts for around 60% of the UK economy and two-thirds of the US economy.

Furthermore, while the media has moved on, coronavirus infections haven’t – and rampant infections across the globe unfortunately continues to disrupt supply-chains, which isn’t doing anything to help economic growth or inflation!

As a consequence we believe that Goldilocks conditions are returning as central banks are likely to have to temper interest rate expectations, meaning interest rates will peak at levels much lower than historically, which is positive for global equity markets.

However, despite our positive equity market outlook, we are by no means Pollyannaish as we are fully aware that risks remain – the main one being the developing crisis in Ukraine.

Looking ahead to this coming week all eyes will be on US CPI inflation for January (as this could determine if Fed policymakers opt for a 0.25% or 0.50% interest rate increase in March).

Elsewhere of interest we have UK Q4 GDP; UK industrial production; Chinese PMI; and the University of Michigan consumer sentiment index.

The Investment Management Team