Interest rate rises are back on the agenda and for investors who remember the rapid tightening cycle that followed the pandemic, the latest moves from central banks could make for uncomfortable reading.
While both the US Federal Reserve and the European Central Bank raised rates by a quarter of a percentage point last week, the UK has continued to take a more cautious approach with the Bank of England opting to leave rates unchanged. The decision however was far from unanimous, with one third of members voting for an immediate increase to 4%.
Inflation in the UK remains above the Bank's target and policymakers expect the current energy shock to push prices higher still in the coming months. Against that backdrop, investors should not be surprised if rates are increased at the next meeting in November, which takes place just a week after an Autumn Budget which could provide further clues on the direction of economic policy.
Central banks are primarily responding to an energy-led inflation shock, something that higher interest rates cannot directly solve. History shows that rising oil and gas prices can feed through to headline inflation remarkably quickly but if the energy shock proves temporary, policymakers may have little reason to continue tightening monetary policy.
The greater risk is that elevated energy costs become embedded in the wider economy, feeding through into wage demands, services and broader consumer prices. These so-called second-round effects are exactly what central banks are seeking to avoid. The longer energy pressures persist, the greater the likelihood that further rate rises will follow.
On balance, investors should not automatically assume that this marks a return to the aggressive hiking cycles of the early 2020s. Equally, it may be premature to view recent increases as merely temporary measures. The most likely outcome remains a prolonged period of "higher for longer" interest rates, with the possibility of modest additional increases if energy-driven inflation proves more persistent than expected.
Capital at risk.
