Ear to the Ground

May 12 2023

We start with the UK this week where, as expected, the Bank of England hiked rates by a further 0.25% to 4.5%.  This was the 12th consecutive rise, with there again being split opinion, with 7 voting in favour of the hike whilst 2 voted in favour of no change.  The market is implying that rates will peak at around 4.75% this year before ending the forecast period at just over 3.5%.

The central banks acknowledged that inflation remains too high at its current level.  They now forecast that inflation, as represented by the consumer price index, should fall to 5.1% by the fourth quarter of this year.  This compares to the 3.9% forecast made in their February forecast, highlighting how inflation is proving stickier than initially thought.  They of course forecast that it will return to 2% over the period.  Helping reduce inflation will be the fall in wholesale energy prices which we have seen, which should ultimately filter in to lower energy costs for households.  Whilst the prices for some goods and services could remain more elevated, higher interest rates should help reduce the demand for goods and services.  The path which inflation is expected to take can be seen in the chart below from the Bank of England.  

What was perhaps surprising, pleasantly, was the uplift to economic growth expectations.  Whilst the absolute level of growth remains low, they now forecast that GDP growth should be 0.25% in 2023, compared to a contraction of 0.5% in their February forecast.  0.75% growth in 2024 and 2025 is now forecast.  

Preliminary figures for the first quarter released Friday showed that the UK economy grew 0.1%.  Whilst there was growth recorded across the service sector, construction and manufacturing, moving forward an eye will be kept closely on household spending which showed no growth.  This is likely due to incomes continuing to be squeezed due to the high level of inflation which the UK continues to endure.

In the US this week the rhetoric around the debt ceiling has been increasing.  June is when horns between the two parties need to be locked and a resolution reached.  Whilst history tells us that an agreement is normally reached in the end, markets are becoming increasingly nervous however that this will not be achieved.  The 1 month US Treasury Bill is now yielding over 5.8%, significantly above the current Fed Funds Rate of 5%-5.25%, reflecting this risk.  It is not just here where we have seen a market reaction, with one year credit default swaps also witnessing a rise in price.  Everyone will be hoping that this issue is put to bed soon.  After all, no one want to see a US debt default.

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