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WeekWatch -‘Bank increases interest rates by another 0.5%.’ December 22

WeekWatch -‘Bank increases interest rates by another 0.5%.’ December 22

If English football fans thought the World Cup was going to provide a happy distraction to the current recession, high inflation, rising interest rates and a series of national strikes through December, Saturday’s defeat by France will have been a return to reality.

Unfortunately, the coming week is likely to see further difficulty, if, as expected, the bank increases interest rates by another 0.5%. This would mean the UK ends 2022 with interest at 3.5%, compared to the 0.25% with which it began.

Indeed, Mark Dowding, Chief Investment Officer at BlueBay, described the outlook in the UK as ‘grim’, noting: “With real disposable incomes forecast to fall 7% over the next two years, workers across several industries – railways, teachers, nurses, postmen, border control – are striking on higher wage demands. With no political will to change direction, the strikes look set to continue into 2023, paralysing many parts of the economy. Meanwhile, the Bank of England is boxed in, given the mortgage rate pass through onto the economy. We continue to believe that until there is the political will to bring inflation down, from the government and its institutions, the UK’s economic vulnerability will be laid bare.”

Turning to China, sentiment has become generally more optimistic as of late. Unlike the West, which moved away from lockdowns at the start of the year, China has maintained a ‘zero-COVID’ policy, whereby scores of Chinese cities have spent much of the year in lockdown.

This has led to growing protests and, over recent weeks, the government has begun to water down these measures as a result.

Moving away from lockdown brought at least short-term joy for investors in China, and the MSCI China index closed the week 6.6% higher.

While it is too soon to judge the impact that an end to lockdown in China will have in the longer term, Absolute Insight’s Adam Wolfe highlighted four measures to keep an eye on:

  • What happens to Chinese public health as the country opens up
  • The scale of economic disruption as China transitions out of lockdown
  • How the re-opening will impact household sentiment
  • What happens as Chinese savers return to the market?

Summing up his views on the likely outcome, Wolfe noted: “The bottom line: The end of the zero-COVID policy increases the chances that China’s economy will boom in the second half of next year. But the path forward will be messy. Tracking the public health response, economic disruptions, household sentiment, and financial stability will be key over the next six months.”

One area that China’ re-opening might impact, globally, is inflation. The zero-COVID policy has helped reduce inflationary pressures this year by reducing demand. If China re-opens, demand will rise again.

Inflation in the UK hit double digits this year. However, there were signs that it might be peaking. The Manheim Used Vehicle Index, for example, dropped 0.3% in November (or 14.2% compared to November last year). Meanwhile, US housebuilder Toll Brothers’ CEO has recently suggested that building costs are beginning to come down.

However, Martin Hennecke, our Head of Asia Investment Advisory and Communications, warns: “Investors might be well advised not to become complacent about inflationary risks altogether, noting that a weakening US Dollar, China re-opening unleashing pent-up demand and, somewhat ironically, higher interest rates themselves, could all turn out to rekindle inflation longer term.”

Turning to the US, two key updates coming this week will be the release of the latest inflation data as well as a Fed meeting to decide the scale of the next interest rate rise. Somewhat counter intuitively, US markets fell last week due to strong economic data. The reason for this is that stronger economic figures could give the Fed more wiggle-room to increase rates.

With different parts of the global economy at varying stages of their post-COVID recovery, it is worth again emphasising the importance of having a well-diversified portfolio to smooth out some of the volatility that markets are currently experiencing.

BlueBay is a fund manager for St. James’s Place.

 

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