27th June 2023
Persistent UK inflation struggles dominate economic news
Expectations in the lead-up to last week were for a moderate drop in inflation, given that the Bank of England (BoE) had already raised central interest rates multiple times. The US and eurozone both reported drops in their inflation the week before.
The BoE responded to this news by raising the basic rate of interest to 5% – a 0.5% jump – which was larger than many expected. They also indicated that further rises should be expected over the rest of the year.
Speaking to broadcasters after this news, BoE chief Andrew Bailey reiterated the importance of reducing inflation to its 2% target. He said:
“To do that, I have to be clear – and we expect inflation to come down this year – to do that we cannot continue to have the current level of wage increases. And we can’t have companies seeking to rebuild profit margins which mean prices continue to go up at their current rates.”
The risks of high inflation are widely known, and reflected in the average weekly shop, but the dangers of higher interest rates are becoming an increasingly political issue for the government. Think tank Resolution Foundation estimate that according to market trends, households remortgaging next year will experience an average annual mortgage bill rise of £2,900. Next year there will also be a general election.
It’s unsurprising that these higher-than-expected inflation and interest figures caused markets to fall generally in the UK. The FTSE 100 ended the week down 2.4%, while the FTSE 250, which is more volatile, ended 5.1% down.
Markets fear recession
Azad Zangana, Senior European Economist at Schroders, said market reactions indicated rising fears of a recession. He added:
“The BoE recently admitted that its forecasts have not been performing well enough, and an external review of its processes may follow. It suggests that the Monetary Policy Committee (MPC) is no longer placing much emphasis on its analysis, and instead being forced to raise interest rates until the macroeconomic data worsens. Given that interest rates work with a significant lag, lengthened by developments in the mortgage market, it may mean that the MPC can no longer wait and allow inflation to fall back more gradually.”
The BoE is due to release a Financial Stability Report in July, which, given recent events, might garner more mainstream interest than usual, as it will likely have a large impact on just how high interest rates can go.
Markets generally down across the Western world
In the US, comments made by Federal Reserve Chairman Jerome Powell at a Congress testimony undermined performance. The S&P 500 posted its first weekly decline for six weeks (-1.4%), with value stocks continuing to underperform.
The US economy has continued to perform relatively well despite rising interest rates. In contrast to the UK, inflation has fallen throughout the year – although it remains well above the 2% target. Although the Federal Reserve paused interest rate rises last month, it made clear this was only a temporary halt and that more increases were probably on the way.
Kristina Hooper, Chief Global Market Strategist at Invesco, noted:
“If the Fed does tighten two more times this year, I believe it really risks overkill – sending the economy into a significant recession. I’m sounding like a broken record, but I’ll say it again: there is a lengthy lag between when monetary policy is implemented and when it actually shows up in the real economy data, which Powell acknowledged in the press conference. We haven’t seen much of an impact yet because of that lag. That’s why we have to worry so much about overkill.”
Poor performance was recorded elsewhere. Growing rate hike expectations and recessionary fears were also an issue on the Continent, with the MSCI Europe excluding UK Index ending the week down 2.8%. Moving to Asia, the Nikkei 225 in Japan fell by 2.7%, although this may have reflected profit-taking after an incredibly strong start to 2023. As for China, the Shanghai Composite lost 2.3% in what was a holiday-shortened trading week.