This week we have seen inflation continue to dominate the news in financial markets. Following last week’s interest rate decision in the US, several members of the US Federal Reserve have given their view of the outlook for inflation, sometimes painting a slightly confusing or contradictory picture. However, chairman Jerome Powell’s appearance before Congress did enough to reassure markets of the Fed’s willingness to ignore short term inflation, and yields on US government bonds remained steady this week.
In the UK, the Bank of England focussed on inflation as well, predicting that CPI will rise above 3 per cent this year. Its analysis puts current inflation down to the recovery from artificially low prices during lockdown last year and supply bottlenecks caused by rapid economic reopening this year and says the unwinding of the furlough scheme means inflation will not spread through to wages. Even the sight of oil above $75 dollars a barrel this week didn’t stir concerns about longer-term inflation as oil is not as powerful a driver of global inflation as it used to be.
UK: BANK OF ENGLAND HOLDS RATES DESPITE RISING INFLATION
The Bank of England’s Monetary Policy Committee voted to leave interest rates at 0.1 per cent and maintain its bond buying programme at its current level. Although inflation has risen above the bank’s 2 per cent target, the vote to keep interest rates at their current level was unanimous and only one of the nine committee members voted to reduce the bank’s bond purchases.
The bank remains confident that inflationary pressures will be temporary as ‘base effects’ pass through the inflation calculation, such as the very low oil price this time last year, and temporary supply bottlenecks are removed. It warned that headline inflation will exceed 3 per cent this year as higher energy prices add to short-term reopening price pressures. But it says that although unemployment remains low there is still capacity in the labour market, so we are unlikely to see upward pressure in wages. Consumer confidence and consumer spending remain key factors and for now they remain far below pre-pandemic levels.
OIL: BRENT CRUDE RISES ABOVE $75
Brent crude pushed above $75 a barrel for the first time in two years earlier this week. This is a sharp recovery from a year ago when Brent was trading at roughly $40 a barrel as coronavirus restricted demand. Expectations of elevated prices have increased as oil producing nations continue to restrict supplies and demand increases as global economic recovery continues. The oil-producing OPEC nations are predicted to keep production at its current low level during their meeting next week.
The Bank of America recently forecast that oil is expected to trade above $100 a barrel next year as the world recovers from the pandemic and travel demand increases. However, there are many factors that could affect this forecast. The potential for Iranian oil coming back on the market has not yet impacted the price but if talks to revive the Iran Nuclear deal are successful this could quickly add 2 million barrels a day to global supply, while an oil price above $50 makes many mothballed US shale oil wells profitable again.
EQUITIES: US BANKS CLEARED TO RESUME DIVIDENDS AND BUYBACKS
Big US banks and their investors continue to reap the benefits of government coronavirus support measures. The surge in stock market listings, corporate bond issuance and sharp increase in market trading over the last 18 months have all boosted large banks’ revenues. Government support has also kept loan defaults by individuals and businesses very low. This week the largest US banks passed the latest round of stress testing by the regulators, clearing the way for investor pay-outs of hundreds of billions of dollars in dividends and share buyback programmes, as the regulator allows banks to release funds it had asked them to put aside to meet the cost of bad loans.
Banks and financial services are traditionally seen as businesses which do well during periods of steadily rising inflation. So far this year value sectors in general have seen their share prices rise faster than the wider US market, but the rise in the share prices of the big US banks this week has added to very strong recent outperformance.