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In our Market Monday insights, Prosperity Investment Management examines the latest developments across the globe's biggest financial markets - providing you with all the latest information you need to know.]
Bank of England raises interest rates by a half point to 5%
The Bank of England has raised interest rates again by a half point to 5% as it ramps up its efforts to tackle stubbornly high inflation.
In what will be seen as a major move, the Bank’s monetary policy committee (MPC) increased rates for the 13th consecutive time to the highest level since 2008 as a spike in inflation takes hold.
Before the decision was announced, financial markets were evenly split on whether the Bank would vote for a half-point rise or a smaller quarter-point increase.
The latest rise in borrowing costs comes after figures on Wednesday showed inflation remained unchanged at 8.7% in May, driving expectations that the central bank would have no choice but to respond. Inflation was expected to fall to 8.4%, which would still have been well above the Bank’s recent 2% target.
The Bank said that it would continue to watch for persistent inflationary risks, and would push interest rates higher if absolutely necessary. Financial markets reacted to the rate hike by betting the central bank would be forced to raise its base rate above 6% before the Christmas period.
Experts warned the recent approach from the central bank to squeeze high inflation out of the system risked tipping Britain’s economy into recession, as tougher increases in borrowing costs only reduce households’ disposable income and drastically decrease consumer demand for goods and services.
The move comes as households across the country face a massive surge in mortgage repayments as the impact from earlier rate hikes trickles through to the cost of home loans, in a development heaping pressure on the government as millions of families struggle with soaring bills.
In a recent fortnight of turmoil in the mortgage market, high-street lenders and building societies had rushed to pull hundreds of cheaper deals on new home loans before the Bank’s latest decision, while pushing up the cost of a typical two-year fixed-rate mortgage above 6% – the highest level since Liz Truss’s disastrous mini-budget in the autumn of 2022.
European business activity slows in June as higher interest rates begin to bite back
Business activity growth in Europe slowed in June, pointing to a difficult end to the second quarter, according to preliminary data Friday.
The euro zone’s flash composite Purchasing Managers’ Index dropped to 50.3 in June from 52.8 in the previous month. This was below the 52.5 expected by analysts. A reading above 50 marks an expansion in activity, while one below 50 marks a contraction.
The European Central Bank has been increasing interest rates consistently for the past 12 months in an effort to bring down inflation. Higher rates can lead to higher costs for companies across the bloc, however, and so often become a drag on output.
On a country-by-country basis, data earlier in the day from Germany also showed a slowdown in Europe’s largest economy. The German flash composite PMIs fell to 50.8 in June from 53.9 in May. This was below market expectations.
Germany entered a technical recession in the first quarter of the year, after contracting 0.3% over the three-month period. In the final quarter of 2022, Germany’s economy shrunk by 0.5%.
It was a similar story in France, where the composite PMI sunk to 47.3 from 51.2 in May, well below the 51 expected. This was primarily due to weakness in the services sector.
Euro zone bond yields extended their falls following data, with the yield on the 2-year German bund dropping to 3.17% in early trade and the yield on the 10-year benchmark lowering to 2.36%. An economic slowdown tends to be negative for bond yields.
Turkey hikes interest rates as Erdogan looks for economic U-turn
Turkey has hiked its main interest rate from 8.5% to 15%, reversing one of President Recep Tayyip Erdogan's unorthodox economic policies.
The 6.5-point rise was far lower than economists were previously expecting, but it marked a major shift in policy by his new economic department brought in to tackle rampant inflation. Turkey's leader has until now insisted on keeping interest rates down for the foreseeable future.
Inflation is almost 40% and the country is firmly in the grip of a cost-of-living crisis. The head of Turkey's central bank, Hafize Gaye Erkan, was only recruited from the US this month in the wake of Mr Erdogan's re-election as president as he looked to make sweeping economic changes.
Her decision marks the first rise in interest rates since December 2020, after a turbulent period in which three central bank governors were fired in less than two years, as they sought to stick to orthodox economic policies.
Although the increase almost doubles Turkey's policy rate to 15%, it is far less than many economists had forecast. US-based investment bank Morgan Stanley had suggested it would go up to 20%, while Goldman Sachs said it could hit 40%.
In its statement the bank's monetary policy committee made clear that Thursday's move was the start of a gradual process, with the target of bringing inflation down to 5%.
President Erdogan's problem is that Turkey's inflation rate remains stubbornly high and its central bank's reserves have fallen to drastically low levels, after it spent billions of dollars previously trying to prop up the declining lira.
Interest rates have come down from 19% two years ago to 8.5% in recent months and the change in direction will have repercussions for a country already in an economic crisis.
Turkey's economy had grown dramatically in the early years of President Erdogan's leadership. But in recent years, he has ditched the traditional economic approach by blaming high inflation on high borrowing costs and is now seeking to stimulate economic growth as a result.
In the past five years, the Turkish currency has lost more than 80% of its value and foreign investment has plummeted. Turks are now trying to move foreign cash out of local banks.
