May 6 2022
Central banks were back in the limelight this week. Sound familiar? On Thursday the Bank of England raised the base rate by 0.25% to 1%, in line with market expectations. This was the 4th consecutive rate hike. Six of the MPC voted in favour, whilst the remaining three voted for a 0.5% hike. The committee noted that inflationary pressures continue to intensify following the invasion of the Ukraine and also the current issue in China, where ships are jammed waiting to get into the Port of Shanghai. The importance of the latter should not be understated. In terms of standard shipping containers moved each year, this is by far the busiest port in the world, at 47m. To give this some context, Rotterdam, the busiest port in Europe, moved 15.3m in 2021.
The Bank now forecast that inflation could peak at c. 10.25% this year in Q4, the highest rate which has been seen in the last four decades and higher than the previous forecast of c. 9%. This change reflects the removal of the energy price cap in April and following the next removal in October. It is also due to higher expectations for higher food, core good and services prices. This squeeze on household incomes leads the Bank to now forecast the economy to shrink later this year and in 2023, with a -0.25% predicted for the latter. The increase in the cost of living is having a deeply negative effect on UK consumer confidence. There was no move on the size of the central bank balance sheet, but now rates are up to 1% discussions are now to be more robust about what is an appropriate level.
This week also saw the FOMC meet. Here they also increased rates, this time by 0.5% to the range 0.75%-1%. They also indicated that they are likely to increase by 0.5% at the next couple of meetings as they look to combat high inflation. Some market commentators had been forecasting a 0.75% hike at this meeting and possibly the next, but Chair Powell was quick to say that this was not in their thoughts at present.
Unlike the Bank of England however they did announce that balance sheet reduction will start in June. This will be for an initial $47.5bn for three months before rising to $95bn after that, split between Treasuries and mortgage backed securities. The stock market took kindly to the news on Wednesday but these gains were sharply reversed on Thursday following the release of much higher than expected unit labour costs. This surged 11.6% in the first quarter against an expected 9.9% jump. Whilst some of this move was attributable to higher wages it was the scale of the fall in productivity which took the market by surprise.
Whilst inflation is certainly the talk of the town, research from CrossBorder Capital suggests that when it comes to asset prices, in particular equity markets, it is liquidity that we should be watching. Their research shows that the relationship between the level of the S&P 500 and liquidity provided by the Federal Reserve is strong. They estimate that each $100bn of increased liquidity added c. 50 points the S&P 500 index. As stated above, they are about to go into reverse. Certainly one to keep an eye on moving forward, with some early indications already been seen of this coming to fruition. Too difficult to tell though whether this is correlation or causation, two very different things.
Perhaps to end we should spare a thought for those trying to cope with inflation in Turkey, where it is currently running at almost 70% year on year. Hopefully this is something we won’t see in the UK anytime soon.
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