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WeekWatch -‘Due to soaring energy and food costs, consumer prices rose 8.6% in June, year on year – the highest figure ever recorded’ July 22

WeekWatch -‘Due to soaring energy and food costs, consumer prices rose 8.6% in June, year on year – the highest figure ever recorded’ July 22

Equities were generally positive last week, even as the European Central Bank (ECB) pushed through a 0.5% interest rate hike, its first upwards move in more than 11 years.

The base rate, which has sat below zero since 2014, now stands at 0.00%, with further increases expected over the coming months as the bank tries to tame surging inflation.

Due to soaring energy and food costs, consumer prices rose 8.6% in June, year on year – the highest figure ever recorded.

Markets have reacted negatively to interest rate rises announced earlier this year by other central banks, but last week the MSCI Europe Ex. UK finished up 3%, with similar performances from the German DAX Performance and France CAC 40 indexes.

Azad Zangana, Senior European Economist and Strategist at Schroders, suggested markets may have reacted this way as the changes were warranted and expected.

“The ECB should continue to raise interest rates at a steady and accelerated pace to reduce the risk inflation becoming entrenched,” he said. “The Schroders forecast has the main refinancing interest rate reaching 1% by the end of this year, but it now appears that a target of 1.5% may be more appropriate.”

In the US, the S&P 500 rose by 2.6%, with the technology-heavy NASDAQ closing the week 3.3% higher.

Equities could be bouncing because investors may now be inclined to believe that a lot of the bad news is already priced into the market, after a large correction over the course of H1 this year, suggested Zahra Ward-Murphy from Absolute Strategy Research.

“Those taking this view were encouraged last week by a fund manager survey highlighting the significant extent to which investors had reduced risk and equity positions vs. cash.”

A second possible reason for better performance that some are expecting that central banks will have to pare back rate hike plans as the economy slows.

This latter theory is likely to be pushed to the test later this week, with the US Federal Reserve widely expected is increase its central interest rate by 0.75%, after US inflation hit 9.1%.

Turning to the UK, the FTSE 100 rose 1.6%, as the battle for Boris Johnson’s successor continued, with Rishi Sunak and Liz Truss the final two contenders. The two have so far been promoting two outlined divergent fiscal policies. Truss has pitched her tent around cutting taxes quickly, while Sunak has said he would wait until inflation falls before cutting taxes.

“What will really matter is the economic backdrop when the new PM walks into No. 10 Downing Street on 6th September (the winner of the poll of Conservative Party members will be declared on 5th September),” argued Ruth Gregory, Senior UK Economist at Capital Economics. “We suspect that by the time the new PM takes office, the economy will be in a recession. That will make it very hard for even the more fiscally-restrained Rishi Sunak to resist loosening fiscal policy.”

Central banks are attempting to walk a thin line of increasing interest rates just enough to bring down inflation, but not so high as to cause a recession. With economic growth slowing in many markets, however many believe we are likely to see some form of recession this year.

However, Tom Beal, our CIO points out that stock markets don’t always fall in recessions.

“A lot of that pain in markets is exhibited before you get into that recessionary period. So while it looks like we might be entering a recession from here, it doesn’t necessarily mean markets are going to fall.”

Looking ahead, Cristina Hooper, Chief Global Market Strategist from Invesco, noted: “Stocks have been beaten down. That doesn’t mean we won’t see more downside for some stock markets around the world, especially given that earnings expectations are likely to be adjusted downward. But I believe we are far closer to the bottom than the top — and meaningful positive catalysts could present themselves in coming months.”

Invesco and Schroders are fund managers for St. James’s Place.

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