CENTRAL BANKS CHOOSE TO WAIT AND SEE AS HIGH INTEREST RATES TAKE HOLD

CENTRAL BANKS CHOOSE TO WAIT AND SEE AS HIGH INTEREST RATES TAKE HOLD

This week we had two eagerly anticipated but equally unsurprising interest rate decisions. Both the US Federal Reserve and the Bank of England elected to keep interest rates where they are. In the UK inflation is coming down slower than hoped for and in the US economic growth is stronger than expected. Both banks are waiting for the impact of previous rate hikes to take effect and are happy to sit on their hands for now.

Despite nothing changing the market has reacted aggressively anyway. The number of “higher for longer” and “the new new-normal” blog posts, opinion pieces and research notes we’ve received in the last couple of days is astounding. Everyone it seems is starting to believe this time really is different and high rates are here to stay. With the typical delay between rates going up and the economy feeling the impact being between around 18 months, and this being month 16 since rates started rising, we feel this might be a little premature. Like the banks, we’re happy to wait and see.

EUROPE: TIGHT CONDITIONS SLOW EU ECONOMY

This week brought both positive and negative news from the Eurozone. Inflation in the bloc declined more than expected, dropping sharply from 4.3% to 2.9%. This is the lowest reading since July 2021 and reinforces expectations that the ECB will not raise interest rates further. The decline in food inflation played a role, and it also contributed to a drop in the shop price inflation in the UK, which fell to 5.2% this week. Falling energy prices also helped lower the inflation reading, although this may soon change due to the pressure the Israel-Hamas war is placing on energy prices.

Unfortunately, the falling inflation was accompanied by a drop in economic growth. The Eurozone economy shrunk by 0.1% in Q3. This was the third time in the past four quarters that the Eurozone economy failed to grow, and it is now on the brink of a winter recession. Germany, Europe’s biggest economy, contracted by 0.1%. Smaller European economies can be disproportionately impacted by this as they tend to rely on German consumer activity.

RATES UNCHANGED AS AMERICAN CONSUMERS CONTINUE TO SPEND

Both the Bank of England and the Federal Reserve have announced that they will keep their interest rates unchanged. This decision will leave UK rates at 5.25% while the US remains at 5.5%. In their respective press conferences, Andrew Bailey and Jay Powell communicated similar messages – proceed with caution. This may look different across the two economies which are each facing a distinct set of challenges.

The US economy grew by 4.9% in the third quarter of 2023, with real consumer spending increasing by 4%. This indicates the strength of the US economy. However, with rising inflation, the Federal Reserve may be inclined to raise interest rates at their next meeting. Meanwhile, the Bank of England faces the challenge of combating inflation with a weak economy. According to their own projections, GDP growth will be limited to just 0.1% in Q4 and will remain stagnant throughout 2024. Keeping rates high for too long may result in a recession in the UK, but lowering them too early may lead to persistent inflation.

EQUITIES: HIGH COSTS CHALLENGE RENEWABLE INDUSTRIES

Sustainable energy providers are facing mounting cost pressures, and this has been evident in the recent announcement by the world’s largest offshore wind developer, Ørsted. The company has stated that they have no choice but to halt work on two crucial projects off the New Jersey coast due to supply chain delays, higher interest rates, and tax credit changes resulting from the Inflation Reduction Act (IRA). This announcement has led to a significant drop of 26% in their share value.

Currently, offshore wind farms generate about 13% of the power in the UK, and they are a crucial part of the country’s strategy to cut CO2 emissions. In contrast, the United States, under the Biden administration, is taking a different approach. The IRA aims to subsidise the infrastructure of green industries to keep prices competitive with fossil fuels. Toyota is the latest company to benefit from the act, having agreed to invest an additional $8 billion in its battery manufacturing plant in North Carolina.