CENTRAL BANKS LEAVE RATES UNCHANGED AS MARKETS LOOK TO HIGHER FOR LONGER

CENTRAL BANKS LEAVE RATES UNCHANGED AS MARKETS LOOK TO HIGHER FOR LONGER

This week was dominated by interest rate decisions as the US, UK, Japanese and Swiss central banks all voted to leave rates unchanged. Markets expect to see only minimal tightening from here as banks wait for the impact of rate hikes already announced. This week’s meetings still had an effect on markets. The dollar continued to rise strongly against pretty much every other currency and US Treasuries have declined again. The reason is that the Fed’s higher for longer narrative has firmly taken hold in the US. This week’s very low new jobless claims add further weight to the argument that rates need to remain at a restrictive level for long enough to drive inflation back to target.

The Bank of England has also pushed the argument in favour of keeping interest rates high. However, the UK economy is in a much worse position than the US. Although consumer sentiment is improving, it is still far from positive. Meanwhile retail sales continue to fall and activity in all sections of the economy appears to be in contraction. The end of rate hikes will at least bring relief to the property market as mortgage rates fall.

INTEREST RATES: BOE, FED AND SWISS BANK LEAVE RATES UNCHANGED

The Bank of England left interest rates on hold after a surprise drop in the inflation rate provided room to pause the rate hiking cycle after 14 consecutive increases. There is still potential for further hikes as four of the nine Monetary Policy

Committee members voted to raise rates. The Federal Reserve also left rates unchanged but indicated that at least one more hike is likely this year and it committed to keeping rates elevated to make sure inflation is tamed. The Fed’s commitment to keeping rates high caused US government bonds to sell off, driving US Treasury yields to their highest since 2007. The dollar’s recent strength continued and sterling fell sharply after the BoE decision.

Other central banks have also been reviewing their interest rates. While the Norwegian and Swedish Central Banks increased by 0.25% as inflation remains stubbornly high. However, the Swiss National Bank surprised markets as it joined the US in keeping rates on hold as inflation has stabilised within its target range.

UK: EASING FOOD PRICES CAUSES SURPRISE DECLINE IN INFLATION

Inflation unexpectedly fell last month as the increase in food prices slowed and a drop in services activity caused the Consumer Prices Index to drop slightly to 6.7%. Core inflation (excluding volatile fuel and food prices) also slowed as it fell to the lowest rate since March. Lower inflation allowed the Bank of England to keep interest rates on hold and mortgage borrowing costs are now expected to continue falling.

Improving inflation was generally welcomed by investors and policymakers, but there are signs inflation may remain high for some time. The recent decline is partly due to the slowdown in food inflation but, at 13%, this is still very high. Commodities, including crude oil, raw materials and some foods have also been rising in recent weeks. The OECD said central banks will need to keep rates elevated to deal with sticky inflation and it expects the UK’s core inflation rate to remain higher than other developed countries.

EQUITIES: HIGHER OIL AND END OF RATE HIKES BOOST UK SHARES

UK equities have lagged other developed markets during 2023, but this gap has closed recently as the UK benefited from a number of tailwinds. Rising oil prices have helped energy companies like Shell and BP generate some of the largest gains. Miners have also risen strongly due to higher raw materials prices. The potential peak of UK interest rates has been welcomed by investors as inflation cools and unemployment remains low. Defense and aerospace stocks have also performed well, and the Bank of England’s decision to keep rates on hold caused commercial property and property developers to rise this week.

In the last 30 days the FTSE All Share has risen more than 6%. In comparison, the S&P 500 is up 0.8% and MSCI Europe is up 2.1% in local currency terms. But recent outperformance needs to be seen in context as the UK remains considerably behind other developed markets year to date, and a weak pound has helped boost returns from overseas investments.