The Bank of England (BoE) stole the headlines this week by modestly raising interest rates from 0.1% to 0.25%. It was the first rate increase in the UK for over three years and the BoE has become the first major central bank to act in an attempt to tackle rising inflation. For many this will feel like a big change and that the BoE are decoupling from the rest of the world, but when looking globally 2021 has been characterised by central banks increasing interest rates. Indeed, on Tuesday Chile increased its rates by 1.25%, which marked the 112th interest rate hike by global central banks this year.
Given the rise of Omicron and the expected short-term economic slowdown, the virus will cause the probability of the BoE’s move was only around 20%. As such we saw quite a reaction in both equity and currency markets, with bank shares rebounding and sterling strengthening against a basket of currencies on the back of the news. It’s clear the shift in policy by the BoE was driven by fears around inflation. This week we saw inflation hit a new 10-year high, reaching 5.1%, driven by fuel, energy and clothing. The BoE reported they expect the number to climb to 6% in the coming months, three times the official 2% target level.
The US Federal Reserve had met earlier in the week and although they didn’t change their interest rates, they did indicate that they would end their bond purchase programme by March and potentially increase rates up to three times next year. With above-trend growth, strong consumer and corporate balance sheets and supply-side issues, it is clear central banks are worried about economies overheating and inflation spiralling out of control.
The Omicron variant continues to spread rapidly with the UK recording a record number of cases throughout the week. Although positive cases are spiking, the booster programme roll-out has dramatically accelerated with over 745,000 boosters administered on Wednesday. The impact on global stock markets from the rise of Omicron has been largely muted, much different to the experience in Q1 2020. Markets believe a combination of vaccines, treatments, supportive government policy and healthy consumer balance sheets should support the economy in the short-term, a much different picture to all the uncertainty caused at the onset of the pandemic.
Economic data took a back seat this week. Here in the UK, retail sales rose 1.4% month-on-month, higher than expected, while Eurozone construction output also came in ahead of consensus.
Equity markets have generally lacked direction this week, with the rising threat of Omicron alongside higher inflation acting as a headwind. One asset that has recorded a better week is gold. It’s an asset we hold in portfolios, but which has been a frustration this year. It’s worth noting that it’s mainly held for its defensive characteristics and ability to diversify equity risk. However, if you study the drivers of the gold price, it typically performs well in a falling ‘real’ yield environment – something we have been experiencing for much of 2021, yet the gold price has barely reacted. We expect this to be a short-term breakdown in the trend as opposed to a fundamental change in the drivers of the precious metal and it will continue to be held in portfolios as a diversifying real asset.
While it was opportune to cover gold this week, we don’t expect anything to be happening in the week ahead that will mean myrrh or frankincense grab the headlines.
Andy Triggs | Head of Investments, Raymond James, Barbican
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