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06 June 2022

Market Round-Up

Eurozone inflation hit yet another record high of 8.1% in May, accelerating from 7.4% in April and surpassing economists’ forecasts of 7.7%. Core inflation, which excludes more volatile energy and food prices, also rose above predictions to 3.8% from 3.5% in April. This indicates that broadening price growth is no longer attributable solely to energy costs and mounts pressure on the European Central Bank (ECB) to speed up the tightening of its current ultra-loose monetary policy. The higher-than-expected core measure may be what tips the balance in favour of more aggressive rate rises at the ECB’s next meeting. Chief Economist of the ECB Philip Lane motioned that the bank would increase interest rates by 0.25 percentage points at the policy meeting in July and by another 0.25 percentage points in September, which he described the governing council’s benchmark rate rise. That said, with inflation seemingly out of control, hawks are likely to push for a 0.5 percentage point rise at the vote on 21st July.

Given that inflation is currently four times its 2% target, most ECB governing council members have started to accept that the ECB will need to start raising its deposit rate if it is to tackle the unsustainable price rises. The deposit rate has lingered in negative territory since 2014 in which it currently sits at -0.5%. Despite these concerns, there is a large divide over the pace of the move from a negative deposit rate in which President Christine Lagarde has requested the council to move steadily and adhere to the scheduled 0.25 percentage point rises following the end of the ECB’s bond-buying programme in early July. The ECB had previously promised to continue asset purchases until the third quarter and caused some to believe that its decision to instead stop them in July has led to the caution in rate rises. Where energy prices increased 39.2% in the year to May and the price of food, alcohol and tobacco grew at an annual rate of 7.5%, the problem has become that now high energy prices have seeped into the economy, and inflation is broadening out and becoming entrenched. There will be much pressure on the ECB over the next few months to prevent inflation becoming perpetuated via a price-wage spiral.

Although the Eurozone is starting to heat up more than anticipated, it is the UK that is facing greater concern as a duo of Wall Street banks is precipitating further declines for the Pound as the cost-of-living crisis takes its toll. The Bank of England began tightening its monetary policy in December and has since increased interest rates four times, being markedly ahead of other major central banks. However, this has failed to prevent the Pound losing ground against most key rivals this year. Bank of America strategists have warned investors that the British currency is facing a struggle usually witnessed in emerging markets and that they should hedge for an existential sterling crisis. The biggest losses have been over the past six weeks as concerns have grown over the possibility of a recession. Even with Sterling steadying recently as the US Dollar rally has back-pedalled, it remains close to its lowest level since early 2021 against a basket of its trading partners’ currencies. May has shown the sharpest one-month drop in sentiment towards the UK currency abruptly ending a period of relative optimism.

The UK’s early start in tightening monetary policy has meant that bond yields are higher than other economies including the eurozone, however this tailwind is set to fade as the ECB plays catch up and raises rates. High inflation, a sharply slowing economy and a deterioration of its relationship with the European Union over Northern Ireland is increasing the pressure on Sterling even further. Last year, the currency reached highs of US$1.42 as investors welcomed the currency in the aftermath of the signing of the UK-EU Brexit trade deal in December 2020. It has now retreated to US$1.26, but it is possible that the downward spiral could quickly accelerate to take the Pound to unity with the greenback if the Northern Ireland dispute escalates into a trade war with the EU.

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. The value of investments and any income derived from them may go down as well as up and you could get back less than you invested.
 
Market Round-Up
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