Market Update – 20th October 2021.

The BoE has stolen the show this week following comments over the weekend by Andrew Bailey, the Governor of the BoE, that the central bank “will have to act” to tackle rising inflation.

Consequently, financial markets immediately started to speculate that the BoE will start to increase interest rates before the year is out.

However, Andrew Bailey’s comments don’t guarantee that UK interest rates will soon be higher.

Only last week, two BoE policymakers (Catherine Mann and Silvana Tenreyro) said that there was no rush to increase interest rates.

Furthermore, regular readers of our commentaries, will know that we believe the current inflationary pressures are transitory and that an increase in interest rates will do nothing to solve the underlying problem: higher interest rates won’t correct the current supply-chain disruptions and bottlenecks by providing more lorry drivers or increasing capacity at the world’s ports. Nor will it increase the capacity for semiconductor production or relieve the global energy crisis.

As such, we believe that an increase in UK interest rates would be a policy error, especially given the UK government is also tightening fiscal policy – and the UK economy can ill afford both monetary and fiscal tightening as it will squeeze our budgets and reduce our discretionary spending (and the UK consumer accounts for around 60% of the UK economy).

In fact, we don’t believe we have an inflation problem, as we see this as a transitory/one-time increase – and as we work through the supply-chain bottlenecks and energy costs stabilise (or start to decline as more production comes online), inflation numbers will fall sharply this time next year as the current increases become next year’s ‘base effect’.

Interestingly, ‘base effects’ were clearly on show this morning with the release of September’s UK CPI inflation reading, as inflation fell to 3.1% from 3.2% in August despite the increases we have seen in fuel prices. This fall was a consequence of last year’s ‘Eat Out to Help Out’ scheme, which ended on 31 August 2020 and resulted in an artificially large increase in restaurant prices in September 2020, which fell out of the year-on-year data calculations.

Unfortunately, Andrew Bailey’s comments will ensure the current elevated equity market volatility will remain with us over the next few months.

Investment Management Team

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