Ear to the Ground

March 31 2023

After the events of the previous two weeks a quieter few days was probably in order.  In the UK, economic data was on the lighter side.  We saw UK house prices remain soft, with the Nationwide House Price Index declining 3.1% year on year.  This compared to a consensus forecast fall of 2.2% and was the largest 12 month drop since July 2009.  There have now been seven consecutive months of falling house prices.  The Nationwide meanwhile believe that it will be difficult for the market to gain positive momentum in the near term due to weaker consumer confidence and pressure on household budgets.

In the US there was more data on offer but little which moved markets significantly.  We did see the release of the Core PCE price index, the Federal Reserve’s preferred gauge to measure inflation.  This posted an annual increase of 4.6%, which was marginally below market expectations of 4.7%.

The question on all investors’ minds is whether the fall which we are seeing in inflation will be enough to bring the peak in US interest rates closer.  The central bank will have to take into consideration the impact of the recent stress in the banking sector, in particular regional banks.  Many believe that this will undoubtedly lead to tighter lending conditions being imposed by banks moving forward.  If this is the case, this will potentially do some of the tightening required on the Federal Reserve’s behalf.  The key question is how much.  We have seen some estimates which suggest that this could equate to the equivalent of a 1.5% rate hike.  These are, of course, only estimates and involve a degree of crystal ball gazing, but either way we could be closer to the peak in US interest rates than we initially thought.

We also saw the release of the latest inflation data from the European Union, which eased to 6.9% year on year, to March.  This was below the market consensus of 7.1%.  Whilst this headline figure was moving in the right direction, core inflation, which excludes food and energy, was moving the other way.  This rose to a fresh high of 5.7%.  Despite the issues we have seen with the banks, although confined to the US and Switzerland for now, this figure perhaps justifies the decision of the European Central Bank to hike rates by 0.5% last time round and suggests that more may be on the cards.

This leaves central banks potentially between a rock and a hard place.  They have for some time now been aware of the trade-off between fighting inflation and the potential economic damage which this may cause further down the line.  Interest rate hikes very rarely have an immediate impact, with economists and central bankers estimating that it will typically take 12-18 months for the effect of a hike to come into play.  That is around now since the first ones were made.  The pace at which they have risen, plus the level at which interest rates now stand, will potentially cause a few more market incidents yet, which will likely increase market volatility.  We have seen this in the bond market, perhaps one in the equity market is yet to come to the same extent.  All eyes will certainly be on the next set of quarterly corporate earnings data.

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