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WeekWatch -‘Bank of England’s (BoE) Monetary Policy Committee forecasted inflation for the year to hit 4%’ August 2021

WeekWatch -‘Bank of England’s (BoE) Monetary Policy Committee forecasted inflation for the year to hit 4%’ August 2021

UK markets experienced growth over the past week, as the Bank of England’s (BoE) Monetary Policy Committee forecasted inflation for the year to hit 4%.

While this is notably above the BoE’s 2% target for inflation, and an increase compared to its 3% forecast from May, the central bank maintained the current higher inflationary period was transitory, and that it expected it to return to 2.25% in two years’ time.

On a positive note, the BoE also raised its GDP growth forecasts to 7.25% for 2021, 6% in 2022, and 1.5% in 2023.

These figures were not enough to persuade the majority of its Monetary Policy Committee to change the Bank’s course of action with regards to interest rates and other forms of economic support, and so voted unanimously to keep the current low interest rates unchanged, and 7-1 to leave the Asset Purchase Facility unchanged.

However, it noted that should the economy evolve broadly in line with projections, “some modest tightening of monetary policy over the forecast period is likely to be necessary”. David Page, head of macro research at AXA Investment Managers says he was unsurprised by these actions. He added: “The fact that despite a large upward revision to Q2 GDP from May’s report, that fact that expected GDP is now lower by end-Q3 than seen in May reflects our own outlook on the economy. Indeed, while acknowledging the uncertainty, we still see some downside risk to GDP growth in 2021 compared to the bank of England.

“We forecast UK GDP growth at 6.7% for 2021, compared to the BoE’s 7.25% and 5.7% next year, compared to 6%. However, much of this reflects an expectation of a slower rebound than the BoE, spread more into 2022, which should leave GDP growth for 2023 closer to 2% in our view. This is in part why we still consider a tightening in monetary policy as unlikely in 2022.”

Following the Update, UK markets briefly dipped on the slightly more hawkish tone and higher inflation fears. Overall, however, last week saw the FTSE 100 finish up.

The reason that markets focus on central bank policy is because higher interest rates could be a challenge to the share prices of the companies that have seen their valuations soar over the past year and a half. Some large technology companies, for example, are trading at high valuations relative to their earnings. This is partly due to the way that low interest rates tend to positively impact share prices.

Elsewhere, European shares continued to climb, with the STOXX Europe 600 Index moving further into record territory over the week, as a string of large companies posted growing earnings over the week. This marked the third straight week of gains for the index, as the EU continued to recover from the pandemic.

In the US, Thursday saw both the S&P 500 and the NASDAQ reach record highs in anticipation of the monthly employment data, which was released Friday morning.

When these figures were eventually released on Friday, they revealed the country had added 943,000 non-farm jobs in July. This was above consensus economist expectations, and up from last month’s figures. Over half of the new private sector jobs were in leisure and hospitality.

While these figures undoubtedly make for positive headlines, Ian Shepherdson, chief economist at Pantheon Economics warned some of the devil is in the detail: “Headline payrolls were flattered by a 240K leap in government jobs, only slightly more than we expected and mostly (231K) in state and local education jobs, continuing the reversal of the COVID-19 hit. The rate of increase in this component now will slow sharply.”

It should also be noted that the past two weeks have seen a strong rise in the Delta Variant of COVID-19 in several states, and that these figures won’t fully account for any employment effects this has caused.

Nevertheless, the strong employment growth will be giving US central bank policymakers food for thought ahead of their meeting at Jackson Hole, Wyoming, later this month for the annual Economic Symposium. If the Federal Reserve was planning to announce any shift in tone or policy, it is expected to be made there.

With speculation that the US Government might make an announcement around a rate rise later this month mounting, the NASDAQ fell slightly on Friday, however still finished the week up. The S&P500 grew on Friday, meaning it finished the week at a record high.

Meanwhile Asian markets had a calmer week compared to the end of July, with many markets posting small growths for the week. Due to time differences, any impact from the US job increases will not be seen until this week, however.

Axa Investment Managers is a fund manager for St. James’s Place.

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