Central Banks Believe Above-Target Inflation Will Be Temporary:

Last week we saw above-target inflation continue to dominate the news in financial markets. Following the US’s interest rate decision, several US Federal Reserve members gave their view of the outlook for inflation. All too often though, they painted 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. So, yields on US government bonds remained steady last week.

In the UK, the Bank of England focussed on inflation as well. They predicted 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. Supply bottlenecks caused by rapid economic reopening this year will also have added to the effect. However, the unwinding of the furlough scheme means inflation will not spread through to wages. Even the sight of oil above $75 dollars a barrel last week didn’t stir concerns about longer-term above-target inflation. It’s a stern marker that oil is not as powerful a driver of global inflation as it used to be.

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. It also opted to maintain its bond buying programme at its current level. Although inflation has risen above the 2 percent target, the vote to maintain current interest rate levels was unanimous. 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. ‘Base effects’ they say, will pass through the inflation calculation. By this, they mean things like the very low oil price this time last year, and temporary supply bottlenecks being removed. It warned that headline inflation will exceed 3 percent 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.

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. Last week the largest US banks passed the latest round of stress testing by the regulators. It clears the way for investor pay-outs of hundreds of billions of dollars in dividends and share buyback programmes. It comes 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 that 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 last week has added to very strong recent outperformance.

 

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