26 October 2021
Interest hikes on the horizon?
Last week saw the Bank of England suggest that an announcement of increasing UK interest rates could happen in the next two weeks – however, recovery continued regardless.
Inflation dropped to 3.1% in September, compared to 3.2% in August. A positive sign? Perhaps, but the Bank of England’s chief economist Huw Pill told the Financial Times it was likely to rise to around 5% early next year.
He also gave a clear signal that a rate rise announcement could be made as early as the Bank’s Monetary Policy Committee meeting at the end of next week (4 November), describing the situation as finely balanced.
Evidence pointing towards an imminent rate rise is building – Pill’s comments came hot on the heels of a speech from BoE Chief Andrew Bailey, who said the central bank would have to act to keep a lid on inflation – widely interpreted as a comment on a potential rate rise.
Markets did not react in a panicked manner to these statements, however – the FTSE dropped just 0.24% over the week. Part of the reason for this – as Martin Hennecke, Asia Investment Director at St. James’s Place, notes – is because any increase in interest rates will be gradual and coming from a historically low starting point. He said:
“Central bankers and governments will probably have to toughen their language somewhat soon, though; and at least be seen to take inflation seriously, if not launch some actions here or there – if small ones – to maintain the impression that there is no reason to worry much about inflation…simply because if they didn’t, sovereign yields – and thereby government refinancing costs – would likely rise significantly.”
Nevertheless, it’s prudent to be aware of the growing inflationary risk when considering investment decisions, Hennecke warned:
“Investments that can provide protection from inflation over time include any type of physical assets, of course, but also the asset class of equities as well – noting that companies with an edge in the market will typically be passing on rising costs to customers in the form of higher prices charged for their goods and services… though passing on of costs may not always happen in a linear way, and clearly equity prices can still be volatile and subject to correction risks.”
Counting the cost
As companies look to weather the storm of inflationary pressures, some have begun to pass on these costs to consumers, or suggest that price rises are likely in the future – including Unilever and Akzo Nobel (the parent company of paint brand Dulux).
According to Mark Dowding, Chief Investment Officer at BlueBay Asset Management, there’s currently some room for price increases for consumers:
“With rising prices, sentiment indicators have stalled somewhat recently, but the consumer continues to spend, as highlighted by US retail sales last Friday showing 12% year-on-year growth and Chinese retail sales outperforming expectations. This indicates that, for now, companies have the power to pass on higher prices to consumers, and so those prices are more likely to show up in inflation, rather than impacting corporate margins.”
This has been reflected in recent company results, with several companies beating earning expectations over the past week.
Strong earnings helped buoy US and European markets, with the S&P 500 breaking its own record high by Thursday. The Nasdaq Composite and STOXX Europe 600 both finished the week up, although neither quite reached the historic highs they hit earlier in the year.
Investors on alert
Despite the positives, it’s important to keep one eye on the current challenges – not least the persisting supply chain issues, with the chip shortage especially affecting a wide range of companies. On Friday, for example, Renault revealed it will produce at least 300,000 fewer vehicles this year as a result of a shortage of components. These shortages may well continue into 2022.
At the same time, COVID-19 numbers are continuing to rise in the UK, and energy prices remain high; while the Chinese property industry remains brittle following the struggles at Evergrande, which only narrowly avoided a default last week. Equity prices are therefore rising in the face of these potential challenges.
As always, diversification is the order of the day for investors – playing a key role in helping you achieve long-term returns as different sectors come under different pressure, and at various times.
BlueBay is a fund manager for St. James’s Place.