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07 March 2022

Market Round-Up

Chair of the United States Federal Reserve (Fed) Jay Powell has said that the Fed is prepared to go ahead with the March rate hike in what will be the first interest rate increase since 2018, despite the uncertain economic conditions resulting from Russia’s invasion of Ukraine. The rate hikes are intended to combat surging consumer prices across a broad range of goods and services in which inflation is rising at the fastest pace in 40 years, up 7.5% from a year ago. With the employment level also growing over the past six months, this has led to an extremely tight labour market contributing to rapidly rising wages and, therefore, additional inflationary pressures.

Although the true economic implications of Russia’s attack on Ukraine are not yet clear, some fear that continuing to hike the interest rate will cause stagflation: low growth coupled with rising prices. The current economic environment very much reflects that of the 1970s when the Yom Kippur war led to an oil price shock raising concerns of stagflation among the existing inflationary dynamics. This event describes the nature of war in which a supply shock hits growth, while raising inflation. Markets are also factoring in the possibility of even more aggressive sanctions, for example, cutting Russia off from the Swift interbank payment system, disrupting supply chains which could add fuel to the inflationary fire. Therefore, despite the Fed going ahead with its March rate hike, markets have dialled back expectations of how hawkish the following rate rises this year may be, with traders now expecting five 25bps adjustments as opposed to six over the course of 2022.

Tighter monetary policy may offset the negative impact on consumer and business confidence that results from rising inflation. Lower interest rates, however, have the potential to encourage short-term investment and consumption, but it still does not solve the issue of lower fossil fuel production and, therefore, supply chain issues. A less aggressive rate rise cycle is thus likely to be the most sensible option. Despite monetary policy having a huge part to play in controlling inflation and confidence, it will be fiscal policy that will need to take most of the burden of protecting the most vulnerable from the impact of higher prices. Transfer payments, funded by taxation, will make up a big part of this, along with other government spending.

Those at the lower end of the income scale are also being affected in the UK, in which the Department for Education has announced that it will be lowering the repayment threshold for student loans in England from £27,295 to £25,000 and increasing the write-off period from 30 to 40 years. These changes will apply to University students who are starting from next year onwards. The higher and further education minister, Michelle Donelan, said that the changes are being put in place to introduce fairness into the repayment system. 54% of loans will never be paid back, making the cost of writing-off unpaid loans approximately £161bn which gets passed onto the taxpayer. Raising the threshold should prevent the taxpayer bearing such a high proportion of this cost.

It is not widely thought, however, that all graduates will benefit from these changes, which Dr Gavan Conlon, from economic consultancy London Economics, has said are more likely to increase inequality among the future working generation. He said that the only graduates who will gain an advantage from the new system are the highest earning, predominantly male graduates and most others will be worse off. Currently, it is only those graduates on the highest salaries who clear their loan, and the real interest rate means they ultimately remain in the repayment system, paying more and subsidising those on lower salaries. As the policy changes mean that the repayment threshold will be indexed to the inflation rate rather than average earnings, the real interest rate will be lower so graduates will not have to repay more than they have borrowed. However, this also means that there will be a lesser transfer of wealth from the highest earners to the lowest earners, benefitting the wealthy and punishing the poor. Additionally, extending the period of repayment will mean low and middle-income graduates will be repaying their debt for more of their working life, increasing their repayments by thousands of pounds. Further evidence will be required to determine the desirability of the new system.

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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