Central bankers were firmly in the spotlight this week, with the US Fed and Bank of England (BoE) meeting to set interest rates. Investors focused on both the interest rate decisions and the accompanying statements, to help determine the future path of interest rate policy.
On Wednesday the US Fed held interest rates steady in the US, referred to as a “pause”. While it is possible that we have reached the terminal (maximum) level of US rates in this cycle, the guidance given by US Fed Chair Powell, intimated at one further rate hike in 2023. The US Fed upgraded their economic growth expectations for 2023 and 2024 and with it they expected to keep rates higher for longer in the face of a stronger economy, which is able to tolerate higher rates. Despite not raising interest rates both US equities and bonds sold off on the news. The tech-heavy Nasdaq index, which has been a standout performer this year, bore the brunt of the pain, falling over 1% on Wednesday and Thursday. The US 10-year government bond yield touched 4.5% on Thursday, its highest level since 2007 as investors braced for higher interest rates and inflation over the medium term. The underlying strength of the US economy has been reflected in a rally in the USD against a broad basket of currencies.
Following the pause in the US, the BoE followed suit on Thursday, keeping rates steady at 5.25%. This was a slightly unexpected decision, although the odds of a pause did increase after inflation data was released on Wednesday. Headline inflation in the UK was 6.7%, marking the sixth straight month that inflation has fallen. Core inflation, which strips out energy and food, was reported at 6.2%, considerably below the expectation of 6.8%. While inflation is still clearly an issue, there is now growing evidence that it is moving closer to target and should continue to throughout 2023. This is despite rising oil prices, which have been putting upwards pressure on inflation. It was a split decision for the BoE, with five members voting to keep interest rates at 5.25%, while four members voted for an increase to 5.5%.
Wednesday’s inflation data led to a big jump in UK equities, led by the more domestically facing mid-cap index. Government bond yields also fell (prices rose) as investors lowered interest rate expectations. We also witnessed the pound dip below 1.23 versus the USD this week.
On Friday morning Purchasing Managers’ Index data for Europe and the UK largely disappointed. There was a larger than expected contraction in the UK services sector, which will make the BoE feel vindicated in their decision not to tighten policy any further.
It’s been a mixed week in markets as investors digested the key interest rate decisions. Once again diversification has been important, with unloved UK government bonds outperforming the US this week, while UK equities have also fared better than most – this has been a reversal of 2023 trends to date. Economic data continues to be mixed and we are mindful of the long and variable lags of tighter monetary policy, which leads us to take a diversified and cautious approach to portfolio construction.
Andy Triggs, Head of Investments
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