How are Central banks responding to the energy shock? | The Week in Markets

[00:00:08]Welcome back to the weekend markets. My name is George and I'm delighted to be joined by Harry today to give you an update on some of the key events this week.

[00:00:17]Harry, if we look at this week, we've got Trump who's agreed a deal, oil is flowing, we've seen oil prices come down quite materially. Start of the week, they were $95 a barrel, now below 80.

[00:00:29]Bond yields are down, stock market is up. It's It's quite a time to be a central banker trying to make decisions about policy that's going to affect the global economy. But, in terms of that challenge, we've had three major central bank meetings this week. We've had the Federal Reserve in the US, we've had the Bank of England here in the UK, and of course the Bank of Japan.

[00:00:51]In no particular order, let's have a look through these, and I think it's probably worth starting with the Federal Reserve in the US because what we've seen is not only a change in the expectations, but actually a change in the leadership as well. So, this was Kevin Warsh's first meeting at the helm as chairman of the Fed, and he's Trump's man. So, he was brought in really to lower interest rates, which is what Trump was backing.

[00:01:16]But, in reality, he's walked into a scenario of a massive energy shock, and that's putting upward pressure in terms of inflation. So, it really challenges his ability to bring interest rates down as a key mechanism of control and inflation. So, what did they decide to do?

[00:01:32]>> Yeah, so Kevin Warsh coming in first meeting in terms of him being chair of the Federal Reserve. And the backdrop of the minute just hasn't allowed for that easing bias. Rates haven't been allowed to come down. The Federal Reserve actually kept rates where they were in a band of 3.5% to 3.75% at the upper end.

[00:01:52]Now, this is the fourth consecutive meeting with no change at the Fed.

[00:01:57]And there was no real surprise from the markets.

[00:02:00]Coming into this, we've had inflationary pressures from the Middle East affecting countries globally. It's not just a US story. It's Europe, Japan, the UK, all affected by the disruption that we've seen in the Middle East. So, for one, Kevin Warsh first meeting, maybe not what you'd have expected 3 months ago with an easing bias, more dovish tone. That just wasn't the case.

[00:02:23]Rates are where they are.

[00:02:24]And interestingly, you've also had the other members of that forum. So, they put out projections about what dot plot, which is our projections of where they think rates will be by the end of the year. And the kind of the median level of that has just shifted up a notch reflecting some of those concerns around inflation uh coming from the Middle East, coming from higher oil prices, and commodities not being able to flow through the Strait of Hormuz.

[00:02:52]>> And how how have inflation expectations changed?

[00:02:55]>> Mhm.

[00:02:56]So, as part of that, the inflation expectations have gone higher as well.

[00:03:02]Earlier in the year, the Fed had projected these to be at two around 2.5%, 2.7% um for later in the year. That number now has shifted higher to around the 3.5% mark, which is a really good demonstration for where inflationary pressures are at the minute. It's not just investors and consumers that are feeling that. It's actually the members of the FOMC as well that are seeing those inflationary pressures start to feed through.

[00:03:29]>> So, upward inflationary pressures pushes them further away from the 2% target.

[00:03:35]Changes the dynamic from an expectation of interest rate cuts to actually interest rates being held as they have done in this meeting.

[00:03:43]And even potential for interest rates to move higher between now and the end of the year.

[00:03:47]>> Yeah, that's it. As of today, markets are expecting potentially a hike between now and the end of the year. So, as we mentioned a few months ago, we'd have expected maybe an easing bias by now, but they've stayed on hold, maybe even a hike to come between now and the end of the year.

[00:04:02]>> I suppose what's been different in the US is the US economic backdrop has been relatively robust. So, whilst they've been seeing increased price levels, there's been economic strength underneath that. If you compare that to what we're seeing here in the UK, the Bank of England have got a real challenge where inflation is climbing but they're seeing a cooling in terms of the economic backdrop.

[00:04:24]How did they vote?

[00:04:26]>> As you say, so in a similar way, the Bank of England kept rates where they were at 3.75% and again, no real surprise to investors, to market participants.

[00:04:37]This was widely expected before the meeting.

[00:04:40]So, the committee, as you alluded to George, facing a lot of the same issues as the Fed, the ECB, the Bank of Japan in that inflation has started to creep a little bit higher given some of the pressures in oil prices due to the war in the Middle East.

[00:04:55]So, in terms of the vote split from the Bank of England, the vote wasn't unanimous. Two out of the nine members actually voted to take rates higher at this juncture, but the majority, the other seven members, voted to keep rates where they are.

[00:05:11]And a large part of the reason for that was as you said at the outset, George, that easing in oil prices that we've seen over the past week given the peace deal that's been signed between the US and Iran. Hopefully, we'll start to see oil flowing back through the Strait of Hormuz.

[00:05:27]>> And if we compare that to what we're seeing in other markets, so Bank of Japan, though a major central bank, very different dynamics. We've seen the US and the UK who've been lowering interest rates as with the European Central Bank over recent months and years.

[00:05:44]Bank of Japan are trying to of their economy, so they're trying to actually stimulate the economy, get more growth in there, and with that more inflation, and trying actually bring interest rates up because they've had nearly 30 years of incredibly low interest rates.

[00:05:57]They're trying to normalize that policy or so to more effective tool and lever that they can use to control the economy and effectively growth. If they see growth slow down, they need a tool and a mechanism that they can use. So, the dynamic's very different in Japan, and they are now starting to see inflation come through at a more normal level compared with the developed markets. So, what what did the Bank of Japan do?

[00:06:22]>> That's it. So, you're seeing growth come through in Japan, wage growth at Sorry, a bit of inflation come through, wage growth come through, and with that backdrop, the Bank of Japan actually took rates higher this week. So, starting from a lower base than many Western central banks are starting at 0.75%, they've taken rates up to 1%. So, a 0.25% increase, and again, widely expected by markets, but this direction of travel is important, quite different from what we're seeing elsewhere in that I think as you alluded to, George, you know, rates in Japan have been around 0% for around three decades now. So, it's an important step change and one that's encouraging in terms of the bank's path towards normalization.

[00:07:08]>> So, US on hold, UK on hold, Bank of Japan rising, all facing the same challenge >> Yeah.

[00:07:15]>> of elevated inflation.

[00:07:18]Quite a lot going on. Thanks very much for bringing that together for us, Harry. Thank you for tuning in, and please do tune in on Monday for Morning Markets. Thank you.

[00:07:27]>> This video is not a recommendation or personal financial advice. With investing, your capital is at risk.

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