CENTRAL BANK HIKES ARE IN LINE WITH EXPECTATIONS AS HOPES RISE THAT INFLATION MAY SOON PEAK

CENTRAL BANK HIKES ARE IN LINE WITH EXPECTATIONS AS HOPES RISE THAT INFLATION MAY SOON PEAK

This week the Bank of England and the US Federal Reserve joined the European Central Bank to complete a triumvirate of 0.75% interest rate hikes. The tone taken by the US and UK banks was noticeably different. US Fed chair Jerome Powell was keen to point out that financial markets’ expectations for interest rate are too optimistic. Positive employment figures in the US points to the job market remaining robust and so Powell was keen to emphasis that further hikes are likely to be necessary. The Fed is not for turning, or at least not yet.

In the UK, governor Andrew Bailey was a bit more conciliatory towards markets and said inflation is now expected to peak at 11% this year as he suggested that the hikes already in place may be enough to bring inflation below the 2% target in two years. The bank’s more pessimistic forecast sees inflation peak next year with more aggressive tightening required. In both scenarios the bank now predicts a prolonged period of recession but, with economic data continuing to deteriorate, this doesn’t need much crystal ball gazing at Threadneedle Street.

INTEREST RATES: US & UK CENTRAL BANKS CONTINUE TO HIKE AGGRESSIVELY

The Bank of England and the US Federal Reserve followed last week’s decision by the European Central Bank as both increased interest rates by 0.75%. The UK increase is the largest rate rise in 30 years and takes the Bank of England base rate to 3%. Governor Andrew Bailey signalled rates may not have to rise much further to bring inflation back towards target as the bank’s best-case scenario sees inflation peaking in Q4 with no further rate hikes needed. The alternative outlook sees more persistent inflation causing rates to rise to 5.25% and a two-year long recession.

In contrast, US Federal Reserve chair Jerome Powell indicated that US interest rates will rise further than markets currently expect as US employment remains robust and inflation continues to rise. The difference in outlook from the two central banks caused sterling to drop around 3% against the dollar and US equities and US Treasuries also sold off as markets factored in more aggressive rate hikes to come.

GLOBAL: FURTHER SIGNS OF A WIDESPREAD ECONOMIC SLOWDOWN

Economic growth in the Eurozone slowed sharply in the last three months as GDP rose by 0.2% compared with growth of 0.8% in Q2. Rising energy prices drove inflation in the EU to a record high of 10.7% and this is affecting industrial production. German manufacturing output has declined sharply and the latest manufacturers Purchasing Managers’ Index showed output falling to 45.1 from 47.8 in September.

Europe is not alone in seeing a decline in manufacturing. China’s manufacturing PMI has remained below 50, the level which indicates contraction, for the third consecutive month as Covid restrictions continue to hinder production. The UK’s manufacturing output has also contracted and services output dropped to 48.8 from 50 in September. The UK’s Business Insights and Conditions Survey shows 20% of businesses continue to experience supply chain problems and 40% have taken action to cut energy use. Global shipping firm Maersk said it expects sea freight to decline 2% to 4% as recession slows global demand.

EQUITIES: PROPERTY UNDER PRESSURE FROM RISING RATES

Commercial property values are falling in much of the UK. Shaftesbury and Capital & Counties, major landlords in London’s West End, reported the value of their portfolios has fallen by around 3% in the last six months as rising interest rates weigh on valuations. Both companies say retail trading remains robust and tenants are paying higher rents but analysts expect property values to continue to decline. Separately JP Morgan has forecast industrial property values will fall up to 24% as demand weakens.

Residential property is also feeling the effect of rising interest rates. Data from the Bank of England shows the number of new mortgage approvals fell by more than 10% between August and September as higher borrowing costs put off prospective borrowers. Nationwide reported that house prices fell in September by 0.8% compared with the previous month. The UK’s biggest building society said it expects house prices to fall by around 8% but could fall by up to 30% under a severe recession.