HIGH INFLATION PROMPTS MORE SPECULATION ABOUT THE PATH OF CENTRAL BANK RATE RISES

HIGH INFLATION PROMPTS MORE SPECULATION ABOUT THE PATH OF CENTRAL BANK RATE RISES

This week the inflation melodrama continued, with US inflation numbers reaching record levels. This set off another round of interest rate speculation with even talk of an emergency rate hike being needed immediately over the weekend. That wild over-reaction has died down, but even some cooler heads in the market are revising up their estimates of how aggressively this issue will need to be tackled. It’s a fine line for the Federal Reserve to hold. On the one hand fear of further rates hikes can do quite a lot to tamp down the pressures driving inflation and so reduce the need for future actual rate hikes. On the other, if the markets get too carried away and the actual policy ends up being a surprise that can have negative consequences too.

Elsewhere the UK posted record growth figures confirming that shutting half the country down and then opening up it again does have an effect. With economic activity now almost back to pre-pandemic levels, the real test will be whether growth can be maintained.

GLOBAL: MARKETS SECOND GUESSING CENTRAL BANK ACTIONS

Government bond yields continued to rise and peripheral European countries like Spain and Italy saw some of the sharpest moves as investors’ expectations of a rate rise from the European Central Bank increased. Although ECB President Christine Lagarde tried to ease back expectations about a rate increase, several members of the ECB said they expect the bank to tighten interest rates this year.

In the US, consumer price inflation increased at the fastest rate in 40 years as it hit 7.5% in January. This surprised markets once more and caused the yield on 10-year Treasuries to rise to the highest level since mid-2019. Equity markets have also had a bumpy ride. US tech stocks experienced elevated volatility again but most developed markets are positive for the week. Several of the major contributors to core inflation are already slowing and with energy prices unlikely to keep rising as fast the general expectation is for inflation to fall in the second half of the year regardless of interest rates.

UK: OMICRON HAD SMALLER IMPACT THAN FEARED

UK GDP recovered in the fourth quarter despite the impact of Omicron. GDP fell 0.2% in December as Covid restrictions curbed some activity but, overall, GDP increased by 1% in the three months to the end of December. This reversed a 1% decline in the previous quarter. The stronger-than-expected final quarter saw GDP growth for 2021 hit 7.5%. Annual growth compares well to other developed economies as France recorded annual growth of 7% and growth in the US was 5.7% in 2021.

The recovery in international trade has helped fuel the UK’s recovery. Overall, trade volumes picked up with imports and exports both rising by around £6bn in the final three months of the year. Over the course of 2021 imports of goods rose by 8.4% and exports increased by 4.9% – although these remain below the level seen in 2018. Global trade looks set to recover further in 2022 as global shipping firm Maersk this week predicted most supply chain disruption will have cleared by the second half of the year.

EQUITIES: HOUSE BUILDERS PROSPECTS LIFTED BY INFLATION

The robust UK housing market continues to benefit construction companies. Although house price growth appeared to slow in January, affordability is a potential headwind for builders as the average house price has increased by almost 10% over the last 12 months to £276,759. However, house builders say rising prices, the end of the Covid stamp duty holiday and the phasing out of the Help to Buy scheme have all so far failed to dent demand.

Barratt Development, Bellway and Redrow all reported half year results this week and said that rising house prices are more than offsetting the rising costs they are facing. Redrow’s half year profits were up 16% as rising house prices push up the profit margin on each completed unit. Barratt reported a slight rise in profits and pointed to very strong orders for this year. Share prices are recovering from a poor start to 2021 as increasing profits will help offset the costs of a new government levy to pay for the removal of flammable cladding.