Last week there was a tight call on what the European Central Bank (ECB) would do, and after a rise but accompanied by comments that would suggest there will now be a pause in the interest rate cycle the outlook for this week’s meeting offers different possibilities as each economy is at different points in their inflationary cycle. This could lead to global central bank divergence and sets up different investment patterns to be monitored for risk and opportunities.
In the US, core inflation has continued its downward trajectory driving expectations that US interest rates have now peaked. Indeed, despite recessionary fears being subdued the market is still pricing in chances of cuts next year, which may be a little premature.
In the UK, inflation concerns remain embedded with factors such as wage growth rising. To put the UK inflation outlook in context UK CPI is at 6.8% whilst the US is 3.7% and Europe is at 5.3%. The UK outlook is further complicated with increasing concerns that the UK could dip into recession. So, the market is pricing in a further hike to 5.5 this week, but whether this is the peak will be a tight call. Whilst, the market expectations is for UK interest rates to stay higher for longer. This expectation is helping keep the UK Government Bond (Gilts) curve inverted, ie you will get a higher yield for Gilts over the next 1 to 2 years than you would for 5 to 10 years. For the UK, given the weaker economic outlook coupled with stubborn inflationary pressures we may experience more pronounced changes in expectations, which is likely to make reinvestment risk more problematic for portfolios.
Whilst in Japan, the dynamics are different again. After 30+ years of deflation Japan is one of the only countries where inflation is a positive rather than a headwind. Wage pressures have been growing in Japan coupled with currency weakness and this has increased expectations that the Negative Interest Rate Policy (NIRP) may change by the end of the year.. No change in rates are expected this week but the rhetoric from the central bank may change.
