Equity markets always like interest rate cuts. All things being equal, if the cost of borrowing falls, it will stimulate economic growth. Furthermore, it simultaneously reduces the yield on government bonds, thus giving equities less to compete with in terms of anticipated return, at least in nominal terms. However, investment returns are delivered in real terms, i.e. after the effects of inflation, which is where the present situation assumes greater nuance.
All central banks have inflation targets. The higher inflation happens to be, the lesser the chance of rate cuts and vice versa. The Bank of England, European Central Bank and U.S. Federal Reserve (Fed) have all recently delivered rate cuts, yet apart from the Eurozone, inflation remains significantly above target. In the U.S., consumer price inflation is 2.9% or if volatile food and energy are excluded, 3.1%. With a 2% inflation target, it’s valid to question why rates were reduced. Perhaps the Fed fears economic slowdown? Perhaps Trump’s relentless attacks on Governor Powell are starting to bear fruit? Perhaps the president’s appointees to the Federal Open Markets Committee know exactly why they’re there?
In the U.K., headline inflation is currently running at 3.8% while service sector inflation registers 4.7%; all somewhat adrift of a 2% target. Yet, rates were lowered in August by 0.25% to 4.0%. It’s to be hoped the Monetary Policy Committee doesn’t repeat previous errors by losing control of inflation via a toxic combination of wishful thinking and faulty modelling. Otherwise, a stagflationary shock awaits, if indeed it hasn’t already partially revealed itself. With the price of gold hitting new highs after rising approximately 45% this year and government borrowing rising inexorably, it’s a strange backdrop to the expectation of cheaper debt.
