Written by Cormac Nevin.
The Monetary Policy Committee of the Bank of England (BoE) met last week at Threadneedle Street and decided to raise the Bank Rate by 0.5%, from 4.5% to 5.0%. This was most likely in response to an unchanged UK inflation rate of 8.7% which was published the day before, as well as strong employment and wage data released the prior week which the BoE likely interpreted as the signs of an economy which is running hot. While we have seen sustained falls in inflation in Europe and the US (which we suspect could continue and indeed accelerate) we think inflation could remain relatively higher in the UK due to the unique challenges faced by the economy. These include a labour shortage as well as a multi-decade inability to build sufficient housing or energy infrastructure. These forces will likely see inflation in the UK remain higher than it ought to be, while few of these problems will be solved by higher interest rates. The BoE is threading a precarious needle between its use of interest rates to attempt to cool inflation (compounded by sustained political pressure for them to do something) and inflicting significant damage on the disposable incomes of the portion of the population with variable rate mortgages. While more people own their homes outright than in the 1980s, the size of the outstanding mortgages are far larger for today’s generation of young homeowners.
Elsewhere in the world, we saw evidence that economies are really starting to weaken in Continental Europe and the US. The Purchasing Managers’ Index (PMI) came in significantly lower than expected which suggests to us that higher interest rates in those economies is raising the probability of a recession. Geopolitical risks also remained elevated, as the weekend saw an attempted coup against Vladimir Putin’s Russian regime by a band of Russia’s mercenaries employed on the Ukrainian frontline.
While markets were broadly down over the course of last week, many components of markets appear to be disregarding the growing list of potential challenges. This leaves us comfortable with our preference for substantial diversification in the face of a wide range of potential outcomes.
