Monkey Time

Equity markets had yet another quiet week. Global equities were broadly unchanged in local currency terms but managed a 0.8% gain in sterling terms on the back of the pound falling back from its recent high of $1.26.

There was rather more news on the macro front. The US inflation numbers remain front of mind for the markets but this time failed to contain any big surprise. The headline rate edged down fractionally in April from 5.0% to 4.9%, as did the core rate from 5.6% to 5.5%.

While headline inflation is down substantially from a high above 9%, core inflation has slowed much less and remains well above the Fed’s comfort level. Although the latest numbers support the idea that the Fed is now in ‘pause’ mode, inflation still seems way too high to allow it to start cutting rates later this year as the market believes.

The latest survey of US bank lending officers also seems unlikely to panic the Fed into early rate cuts. This survey is usually one just for the geeks but has moved centre stage as a result of the regional banking crisis. The fear had been that the recent bank failures would prompt an abrupt tightening of lending conditions. Instead, lending standards continued to tighten as they have done over the past year but not dramatically so.

Outside the US, an unexpectedly large fall in German industrial production in March provided a reminder that the Eurozone economy is not out of the woods yet. The collapse in gas prices back to 2021 levels has so far allowed the region to escape falling into recession and led to Europe leading the recovery in equity markets in recent months. But Germany only escaped two consecutive falls in GDP over the winter by the skin of its teeth. And with the ECB determined to continue raising rates, recession still remains a clear risk not only in the US but also the Eurozone.

Talking of recession risk, the good news last week was that the Bank of England abandoned its previous forecast of a recession. It is now just forecasting stagnation over the coming year. The bad news is that the size of its recent forecasting errors suggest not too much faith should be placed in its latest projections. The Sun suggested even monkeys could do a better job running the Bank of England.

The BOE also raised its inflation forecasts, blaming this in good part on food prices. It now sees inflation dropping only to 5.1% by year-end and not returning to the 2% target until early 2025. It also sees significant upward risks to these projections.

This all led to the Bank raising rates by a further 0.25% to 4.5% and sticking to its guidance that if there were evidence of more persistent inflation pressures, then further monetary tightening would be required. Most likely, the BOE will raise rates another 0.25% next month and that should mark the peak.

We continue to believe markets are likely to see renewed volatility over the remainder of the year. Near term, the obvious potential catalyst is the need to raise the US debt ceiling, possibly by as soon as early June. Negotiations over the weekend appeared to show some willingness to compromise and most likely the game of chicken between the Democrats and Republicans will end in an eleventh hour deal of some kind. But in the meantime, it could be a nerve-wracking few weeks.

Rupert Thompson – Chief Economist