In the aftermath of the latest US central bank decision, UK policymakers reveal their next move on interest rates today. Our head of markets discusses why investors are not impressed.
Investors were not convinced by the Federal Reserve’s more conciliatory remarks overnight, as sentiment remained guarded.
The interest rate increase of 0.25% was largely as expected, with a strong implication that one more rise of the same magnitude could signal the end of the hiking cycle. The Fed also acknowledged that the recent chaos within the banking sector could lead to tightening of its own, should banks decide to toughen lending standards to consumers and businesses.
Markets initially reacted positively to the announcement of the rise, if not the accompanying comments, but separate remarks from the Treasury that “blanket insurance” for bank deposits was not on the table reignited concerns for the sector, especially in the event of any further regional bank defaults amid the current interest rate backdrop.
As is the case with other central banks, the Fed remains caught between a rock and a hard place. Inflation for the most part refuses to be budged sufficiently to allow for easier conditions, while the economy as a whole has yet to display a widespread slowdown which could prompt a lighter stance. Indeed, the recent bank developments have made the economic tightrope thinner, with some evidence that there are strains at the smaller end of the banking spectrum given the pace and scale of interest rate rises so far.
In addition, even if the Fed is nearing peak rates, the likelihood of generally tighter lending conditions could further crimp economic growth, leading to earnings downgrades across the corporate sector which until now have largely been avoided.
The ongoing uncertainty of the more immediate outlook has inevitably left a mark on the performances of the main indices, which have drifted below the optimism of the early year. The Dow Jones is now down by 3.4% in the year to date, while the S&P500 has been pegged back to an increase of 2.6%. The Nasdaq remains the stronger performer having added 11.5%.
The memo did not reach Asian markets, where some relatively strong gains were recorded, with investors choosing for the moment to focus on the possibility of stronger conditions in the region, propelled by the reopening of the Chinese economy. There was also something of a tailwind following better than expected results from Tencent, boosting earnings hopes for the broader corporate sector.
However, UK markets chose to take their lead from the weaker finish to the trading sessions from across the pond. The Bank of England, similarly hamstrung by a combination of persistent inflation and the banking sector chaos, is expected to follow the recent lead set by both the European Central Bank and the Fed, raising rates by 0.25% to 4.25%.
The peak rate is now largely forecast to peak at 4.5% later in the year, although inevitably the next move will be data dependent. In any event, for the Bank of England the almost compulsory rise could put further pressure on an economy which has flirted with recession over recent months.
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Such an outlook also took the wind from the sails of the premier index, as the FTSE100 wilted in early trade. Some strength from mining shares was insufficient to stem a broad markdown, including some mild pressure on a financial sector which has been unable to throw off the shackles of recent concerns.
In the year to date, the FTSE100 has succumbed somewhat to the prevalent pressure, although remaining ahead by just over 1%. The more domestically focused FTSE250, however, is now down by 0.6% having written off the gains from earlier in the year and reflecting the choppy economic waters which are likely to follow.
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