Citing Russia’s invasion of Ukraine, the Bank of England (BoE) raised its policy rate by 50-bps to 1.75% last week. BoE also forecasted a recession for the next six quarters beginning Q4 2022. BoE warned headline inflation to rise above 13% at the end of 2022 before declining only in 2023 (currently UK CPI is inching close to 10%). Bank Governor Andrew Bailey has predicted that the UK economy is on course to a period of stagflation – a recessionary environment combined with soaring prices and reduced standard of living. The UK economy is facing “a perfect storm” of challenges: surging commodity prices, a weakening pound sterling and labor shortages due to Brexit – all forebearers of trouble ahead. The BoE seems committed to bring inflation under control and weaken demand enough to lower prices, even if it entails a
recession. It is not too far-fetched to expect a gilt inversion very soon.
On a macro-level, there is a worry that after underestimating inflation, Central Banks may be making a second diagnostic error by refuting the effects of their monetary tightening policies on inducing a recession. Employment is a lagging indicator of the business cycle and it would take a few quarters before the effect of the interest rate hikes are felt by businesses and households. US inflation is gradually reaching a peak and the next rate hikes are already priced in. Any signs of worsening macro-economic indicators could cause the Fed to ease their schedule of rate hikes and could translate to market gains – a bad news could actually be good news situation. Equities remained resilient last week on a relatively good Q2 earning season. European equities were buoyed by a weaker Euro. However, the outlook for the coming quarter will not be so sunny- while Southern Europe may see some revival of tourism, Germany might already be in recession. Bank J. Safra Sarasin notes that consumer confidence in Europe is lower than the Covid lockdown period. Germany will be hit harder than other countries as the heatwave has led to lower water levels in the Rhine disrupting supply chain. Gas inventories are also lower and rationing gas in the winter remains a serious risk
Commodities, FX and Bonds
The US dollar remains strong with the DXY dollar Index gaining around 10% year-to-date. While the overall environment remains favorable to the US dollar, the movement in relation to other G10 currencies does not reflect the recent moves in yield differentials particularly in the EURUSD pair. Bank J. Safra Sarasin expects temporary dollar weakness as the US dollar realigns to relatively lower global bond yields. Crude oil was lower on the back of weakening demand expectations. Wheat futures eased as Ukraine’s first shipment of grains since being invaded by Russia was sign of relief for global markets. However, challenges remain as shipowners are not willing to send their vessels into harm’s way and insurance costs raise supply chain issues to transport the millions of tons of food stuck in the country.
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