Market Overview – 08/02/2022

Global stock markets closed a positive week after a roller coaster start to the year. After the previous week’s meeting of the US central bank and a more hawkish tone from Chair Jerome Powell, it was all eyes on the UK and Eurozone. The Bank of England’s Monetary Policy Committee followed up its December interest rate rise with another last week taking the level to 0.5%. This is the first time the UK has had back to back interest rate rises since 2004. The vote was 5-4 in favour, but the four dissenters argued for a 50bp rise rather than the 25bp increase that was announced. Another rise next month seems very likely. The European Central Bank has been the most dovish of the trio, still arguing that inflationary pressures were transitory. However with Eurozone inflation now running at 5.1%, that narrative is changing. Bank president Christine Lagarde used last week’s meeting to say that inflation risks were tilted to the upside and no longer ruled out an interest rate rise this year. Consequently, bond prices fell, pushing up yields.

There is a common thread to this. Central banks are finally waking up to the idea that higher inflation rates are proving to be stickier than previous thought. A combination of excess demand resulting from huge amounts of fiscal and monetary stimulus as well as supply shortages has pushed prices up in a lot of categories. While it is true that central banks cannot bring gas prices down, they can do something to reduce demand. This is the point where they have to be careful and not hit the brakes too aggressively. The lead times between changes in monetary policy and the subsequent impact on the economy are quite long and the dilemma for the central banks is that the time for tightening policy was probably when we were still suffering the worst effects of lockdown and the full impact of the virus was uncertain! Clearly, this would have been problematic which means that there is a risk of central banks now having to react harder and faster on interest rates if inflationary pressures continue. Markets will continue to watch central banks very carefully over the coming months.

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