Market news today - the Bank of England’s interest rate dilemma

NO doubt about the main story this week here in the UK - the Bank of England is in the spotlight as it decides whether to raise interest rates for a 12^th consecutive time to their highest level since 2008.

How far is enough?

The Bank of England is grappling with the same issues as the Federal Reserve and the European Central Bank (ECB) - how to get on top of inflation without sending the economy into a tailspin. But here in the UK, the challenge is all the more acute because inflation just refuses to come down as quickly as we all hoped.

Back in March another rate hike looked possible but not probable. The odds have shifted since the Bank’s last meeting, however, thanks to yet another double-digit inflation print. Driven by food and wages, prices just keep spiralling higher despite the easing in the cost of fuel and household gas.

So, another quarter point rate hike, to 4.5%, now looks a near certainty this week. And the talk is that interest rates could be 5% by Christmas. Which begs the question, how far is far enough for rates? Will the Bank of England push the UK into an unnecessary recession, or lose its nerve and fail to bring inflation back to heel?

Market glass remains half full

The Bank’s deliberations may matter over here, especially if you are looking to re-mortgage or get on the housing ladder. But from a global perspective what’s happening on the other side of the pond is more important. And here the picture is better.

With last week’s quarter point hike from the Fed looking like the last in the current cycle, despite last Friday’s strong jobs data, investors are looking forward to easier policy ahead. That’s one reason for the S&P 500’s strong start to year, up nearly 10% in the first four months. The other is the better than expected outcome of the now nearly completed first quarter earnings season.

With well over 400 of the S&P constituents now having reported their results, earnings have beaten expectations in about four out of five cases. And they’ve done so by a more than respectable margin. It is starting to look like the Fed may have achieved that hardest of all feats - a genuine soft landing.

As long as….

Investors will be wary of counting their chickens too early. However, two big clouds continue to hang over the markets. The banking crisis refuses to go away completely, despite the apparent easing in pressures either side of the weekend as PacWest Bancorp, the latest regional US bank in the limelight for the wrong reasons, rallied sharply after cutting its dividend and reassuring investors.

The second headwind is the bi-partisan wrangling in Congress over the debt ceiling. Once again, the Republicans and Democrats are playing with fire in that most combustible of arenas, the US bond market. The reality is that neither side would benefit from a real default crisis in the world’s biggest economy - and everyone knows that. The US is very unlikely to default on its debt obligations.

But with US Treasuries acting as the bedrock of the global financial system, even a vague threat that Uncle Sam will fail to pay is enough to spook investors.

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