BANK OF ENGLAND RAISES RATES AND SIGNALS MORE TO COME AS INFLATION PROVES STICKY

This week there is further evidence of the split emerging between the US Federal Reserve and central banks on this side of the Atlantic. The small decline in US inflation takes the pressure off the Fed as it can argue that it should now be given time to see if its efforts have paid off. Over here the data is far from convincing. GDP growth remains weak, at just 0.1% for the first quarter. Unemployment is very low and wages are rising, but signs of weakness are emerging – particularly in employers’ preference for temporary staff over permanent hiring. As the Bank of England has conceded that inflation will remain higher for longer markets now expect several more hikes before it is ready to pause for reflection.

Elsewhere, big tech companies continue to hype the potential for artificial intelligence. However, the impact is already being felt in sectors like publishing, marketing and advertising as investors grow concerned about its impact. Businesses like Pearson and Relx have spent this week outlining the benefits they see in AI but there is likely significant disruption to other sectors as the potential for this technology is tested.

UK: BANK OF ENGLAND HIKES BY 0.25% AS JOBS MARKET BEGINS TO COOL

The Bank of England increased interest rates by 0.25%. The increase was widely expected but it indicated that further hikes may be needed, as it said inflation will remain sticky and the economy is expected to avoid recession. The bank previously tipped inflation to fall to 3.9% by the end of 2023 but it now expects inflation to be 5.1% and does not expect it to return to the 2% target until 2025. The better outlook for global growth and lower energy prices have improved the bank’s outlook for the UK. However, a stronger economy gives the bank more leeway to increase rates to help bring inflation down and markets now expect base rate to rise to around 5% this year.

The UK jobs market remains robust, although there are signs it is starting to cool. The Recruitment and Employment Federation reports that hiring of permanent staff fell for the seventh consecutive month. Recruiter Reed said average salaries for new employees are around 10% up from last year, but it expects this to fall quickly in the second half of the year.

US: INFLATION FALLS BUT GOVT DEBT STAND OFF UNSETTLES BOND MARKET

US inflation slowed further as the headline Consumer Price Index fell from 5% to 4.9% in April. Core inflation also fell slightly to 5.5%. The significant drop in energy prices in the US mean energy is now deflationary, but the costs of housing and services continue to rise strongly. The relatively small increase in new jobs has also supported the view that the US central bank has reached the end of its rate hiking cycle. This helped boost US equity markets, with technology stocks seeing the biggest benefit.

The outlook for US government bonds has been complicated by concerns about the potential for a default. US government borrowing can only be increased by Congress and President Biden only has a short time to convice Republicans to back his spending plans. Some forecasts say the debt ceiling will be hit in early June and short-dated bonds have sold off against the possibility that no agreement will be reached.

EQUITIES: EDUCATION STOCKS LOOK FOR THE POSITIVE IN AI

This week Google announced it has incorporated generative AI in a number of its products, including its online search tool, to improve results. This is the latest attempt by a big tech firm to demonstrate an ability to use natural language chat-based interfaces as a way of improving its service and highlight its importance for future growth. Microsoft recently added ChatGPT to its Bing search function and Meta also pointed to its use of AI to improve Facebook and other social media apps.

Meanwhile other firms have been trying to prove that AI is not a threat. Shares in US tutoring and revision service Chegg fell 40% after it warned that ChatGPT is already causing subscribers to fall. This dragged on the shares of other education service providers. This week Pearson delivered an update to highlight the potential benefits to its business and Relx was also scheduled to give an update on how AI will benefit its business. After a sharp fall last week, UK advertising and education providers have seen their share prices stabilise.