Equity markets liked what they heard from the European Central Bank (ECB) yesterday, with a 0.25% rate rise being followed by suggestions from the central bank that they had taken rates to a level that “if maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation at the two percent target”. Analysts took that to mean no more rate rises. The 4% ECB deposit rate has now eclipsed the previous high in 2001 when borrowing costs were increased to boost the value of the newly launched Euro.
The US Federal Reserve and the Bank of England announce their latest policy decisions next week and we will be keeping a close eye on not just the decision, but also the dialogue that goes with them.
Ultimately, the gamble is on that short term pain will eventually fade and economies can move forwards and the next question will be whether anything will actually meaningfully change or will this boom and bust cycle continue in perpetuity?
The short term versus long term effect of higher interest rates is interesting to analyse. The Barcelona School of Economics suggested earlier this year that higher interest rates were bad news for growth over the longer term, as they choked off green shoots of innovation by increasing the cost of capital and dampening demand. The Frankfurt School of Finance and Management found, one year after a 1% rise in interest rates, that venture capital investment falls by a quarter and patenting and innovation falls by 9%.
Long term growth does matter and if the Conservatives are to stand any chance of success in next years elections, they need to try and find a way to show that things can improve from here. An unlikely task. If you look back at Margaret Thatcher’s popularity, she oversaw the end of a long and sustained period of high inflation, whereas Rishi Sunak’s promise to half inflation by the end of 2023, ignores the blame that has been handed to the Tories for mishandling the economy and bringing to an end a period of price stability. The global pandemic to one side, this is quite a hard accusation to come back from.
Next week we are told that the rate of inflation will rise once more in the UK, due in part to the cost of fuel which fell in August 2022, but rose in August 2023, thus meaning year on year inflation will be higher. This will give the Bank of England (BoE) much to deliberate when they meet on the following day and announce what next for UK rates. The Chancellor Jeremy Hunt acknowledged this likely blip, but remained firm that the BoE maintains its view that inflation will be around 5% by year end (we started the year at 10.7% headline inflation).
There certainly appears to be an air of miscommunication with some of the voting public, as recent surveys carried out by Government officials show that 30-40% of the UK public linked a lower rate of inflation with a fall in prices, not a fall in the rate of price increases, and when the true effect of the current bout of inflation is clearly communicated in Labour’s election rally, dark days are ahead for the ruling party.
For the Conservative party, as with the Bank of England, there remains much to do, but not much time in which to achieve it. Do have a good weekend.