Many economists believe major central banks have finished increasing interest rates now that inflationary pressures around the world have receded.
Stocks and bonds rallied in November, driven by a growing belief that central banks have largely finished hiking interest rates in the wake of easing inflation. With inflation coming down, the consensus is that we have reached the peak of the interest rate cycle. UK shares climbed after the inflation rate dropped sharply in October to 4.6% from 6.7% the previous month – its lowest level in two years. The fall was mainly down to cheaper energy prices. Core inflation, which strips out energy and food prices, fell to 5.7% from 6.1%.
The Bank of England kept its benchmark interest rate range unchanged at 5.25% for the second consecutive meeting – the highest level since 2008. It also warned that it may have to keep interest rates high for an extended period to tackle stubborn inflation. The UK economy flatlined between July and September with 0% growth but avoided a recession. Despite stagnant UK economic growth, the unemployment rate held steady at 4.2% in the three months leading up to September.
There are also signs the squeeze on household finances is easing with wages outstripping inflation, and regular pay up to 7.7% in the three months to September*. Chancellor Jeremy Hunt announced tax cuts for businesses and workers in his second Autumn Statement, with a larger than expected reduction in National Insurance from January. Despite these measures, the Office for Budget Responsibility predicts the tax burden will still reach a post-war high by 2028.
US stocks and bonds rally
Stocks and bonds rallied in November, driven by optimism that central banks have concluded their rate hiking cycle. With many analysts expecting the US to avoid recession with a so-called soft landing, markets have also been more buoyant. The US Federal Reserve (Fed) maintained interest rates in the range of 5.25% to 5.5%, marking the highest levels in 23 years. The central bank has now opted to keep rates unchanged for two consecutive meetings.
While many believe another hike is unlikely, the Fed seems set on keeping interest rates high for the next few months as it seeks to bring inflation down to its 2% target. Following a higher than expected drop in the pace of price rises from 3.7% to 3.2% in October, the first decline in four months, US stocks and bonds rose.
The Fed has raised interest rates sharply since last year in an effort to curb soaring inflation. The fall in inflation makes it less likely that the US central bank will raise borrowing costs again. Job growth was cooler than expected in October, with employers adding 150,000 jobs as the economy grappled with strikes and elevated interest rates. The pace of pay gains slowed, with average hourly wages increasing by 4.1%.
Europe’s economy falters
European stocks gained ground as market momentum strengthened, driven by resilient company earnings. Euro area inflation fell to 2.4% in November, down from 2.9% the previous month, owing largely to falling energy costs.
The euro area economy risks slipping into recession after data showed output shrank in the third quarter. GDP across the 20 countries that use the euro fell 0.1% between July and September compared with the previous three months. The dip follows a rise of only 0.2% in the second quarter.
Stubbornly high inflation triggered by the Covid-19 pandemic and then an energy shock following Russia’s invasion of Ukraine have hampered the European economy in recent years. Interest rate hikes have further weighed on businesses and consumer spending. Survey data indicates a decline in activity in the manufacturing and services sectors, pointing towards a further weakening of demand for goods and services. Even if the region manages to avoid a recession, economists suggest a recovery may still be some way off.
China slips back into deflation
China has slipped back into deflation, highlighting how demand remains weak despite ongoing attempts to stimulate spending. While there was faster than expected growth in retail sales and industrial production in October, China’s factory activity contracted for the second consecutive month, which is a sign of weakening economic momentum. The property sector also remains a drag on growth.
Although China’s imports rose in October from a year ago in US dollar terms, exports fell by a greater than expected 6.4%. The real estate market’s refusal to respond to stimulus measures continues to be a problem for the economy, with property prices falling the most in eight years in October.
In recent months, the Chinese government has increased stimulus measures by lowering key interest rates, freeing up more cash in the banking system and offering support for the property market. Despite China’s economic woes, the International Monetary Fund (IMF) upgraded its GDP growth forecast for China to 5.4%, acknowledging the robust support provided by policymakers.
* Office for National Statistics