11th July 2023

As has been the case for some time now, markets remain fixated on inflation and what this means for interest rates. US headline inflation dropped to 4% in May, largely due to lower energy prices. Core inflation, excluding volatile items like energy and food, slowed to 5.3%, the lowest since November 2021. UK inflation fell in April to 8.7% (though above expectations) but was flat in May. Rising prices in air travel, recreational goods and services (especially admission fees to live music events, computer games and package holidays) and second-hand cars offset falling fuel costs and slowing food inflation; although the latter is still running at a fairly heady 18.3%. Crucially, core inflation reached 7.1%, the highest since March 1992 and above market expectations of 6.8%. Inflation in the Eurozone fell to 5.5% in June, down from May’s 6.1% published figure, but core inflation also picked up to 5.4%.

Generally, whilst we are seeing price rises slowing in some areas, others are proving more stubborn and the path forward isn’t necessarily a clear one. One reason could be wages, which have been moving higher and are supported by tight labour markets. Year-on-year wage inflation in the UK including bonuses was 6.5% in the three months to April 2023, and excluding bonuses 7.3%. Another reason could be that some, though by no means all, companies are using the inflationary backdrop to increase prices and improve profit margins.

Monetary policy has naturally followed suit, with interest rates continuing to rise worldwide. In June the Bank of England raised interest rates by 0.5% to 5% and the European Central Bank by 0.25% to 4%. Whilst the US Federal Reserve paused their hiking cycle it was notable they indicated rates may need to move higher later in the year. One important outlier to this has been China, which is flirting with deflation and actually marginally reduced rates in the last month of the quarter.

The full impact of high rates on consumers is still unclear. Savings made during the pandemic, coupled with higher wages may offset some inflationary effects, but these savings are being drawn upon and the delayed impact of higher mortgage rates may not yet have been fully felt. This will be very important for the global economy and corporate earnings in the quarters to come.

Recession concerns persist, with the Eurozone in a small technical recession and UK GDP only slightly rising in the first three months of the year. While some cracks are appearing in the US economy, strong consumer spending and a robust labour market indicate no immediate recession.