Updated: May 19, 2022
The question of concern currently is at what point does the Bank of England put the brakes on? This matters because equity markets, rightly, do not like it when central banks barge in and end the party.
"Rising wages will push companies to invest more"
The good news is despite the Bank of England Monetary Policy Committee member Martin Weale's hawkish comments recently that interest rates should be increased sooner rather than later, I think monetary conditions are going to remain looser than many think.
The Bank of England's job is to maintain price stability and support the government's objectives with respect to growth and employment. The problem arises when loose monetary conditions cause the prices of assets such as property and equities to rise, making life difficult for those trying to get on the property ladder or to begin saving, but not those of goods and services which may be rising at too sluggish a pace or even falling.
When this happens, the only option for central banks is to threaten to raise interest rates but to not follow through on the threat. This is what is happening at the moment. Not just in the UK, but in the US too.
True, weekly earnings are now rising at 2.7% year-on-year, compared with close to zero a year ago, but this does not mean inflation will take off. Quite the contrary. As Bank of England deputy governor Sir Jon Cunliffe said last month, rising wages will push companies to invest more, boosting productivity and thus easing upward pressure on prices.
He also said that while "there is still more than a hint of 'zombiness' in the corporate sector", there were signs capital had started flowing again to the better companies, which should boost growth.
A final point to make about the prospects for growth and monetary policy is that central banks across the developed world will be very wary about stopping the various recoveries in their tracks. In late 1936, the Federal Reserve raised interest rates and began to shrink its bloated balance sheet, following three years in which the economy seemed to have recovered. The result? The economy contracted by 3.3% and the stock market halved. Governor Carney would not want something similar to happen on his watch.
Published in Investment Week
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.