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To hike or not to hike from here: That will be the key question

03 February 2023

Central banks have started the month by raising rates, but the market reaction has been mixed.

By Jonathan Jones,

Editor, Trustnet

It was a tale of two central banks this week, as the Bank of England raised rates aggressively again, up 50 basis points, while the Federal Reserve slowed down to 25 basis points.

Counterintuitively, the market read the UK Bank’s rise positively, with experts predicting this could be the end of the cycle, while there was discontent in America that its central bank may continue hiking for some time yet, despite the slower pace of increase.

This was because of the rhetoric used by central bank heads Andrew Bailey and Jerome Powell. Yes, in a true case of ‘it’s not what you said but how you said it’, markets were more interested in how the policymakers talked than their actions.

Bailey was decidedly more muted, with his statement reading: “If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.”

Conversely, the Federal Reserve’s message that ongoing rate increases may be appropriate caused a stir, until Powell held a conference call this morning detailing that there would only be “a couple more hikes”, which seemed to ease troubled minds.

It appears that these decisions will shape the rest of the year for investors, who suffered through a tumultuous 2022 but have kicked this year off positively, with 96% of funds making a positive return in January. Those that came out on top were some of the worst performers of last year.

The good times may not last, however, if the Fed and BofE can’t get inflation under control. While there is hope that price rises may slow down this year, inflation remains high, particularly in the UK.

Higher prices have been damaging for markets, but it should be noted that there is no consensus on when and if cost pressures may abate.

Some analysts argue that by the middle of the year we will be looking at easing inflation, partly because the price of oil and other commodities may start to fall back, but also because wage pressures will fail to materialise. Overall figures will also be compared with already elevated prices from a year ago, which will also help.

In this scenario, central banks can stop raising rates, which has added to the cost-of-living crisis by way of higher bills and higher mortgages.

But that scenario is hanging in the balance. Just as easily, prices could continue to skyrocket, particularly with China – one of the world’s fastest-growing economies over the past few decades – coming out of its zero-Covid lockdown initiative.

If manufacturing in the country picks up, demand for commodities may spike, which would elongate the current inflationary pressures around the world.

As ever, being on both sides of the trade is probably the correct call, particularly in the long term. Investors have been looking at income funds to start the year, which should do well if rates continue to rise, with these portfolios chock full of oil majors and banks.

Conversely, they have also been researching Europe and Asia funds, which should get a boost from China’s re-opening and any uplift in global trade.

Whichever is right, backing assets that can work in both worlds seems appropriate for now, at least until there is a clearer macroeconomic picture.

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