Accelerated inflation – the headache for Central Banks

FED made historical move
Eurozone Inflation heavily affected by energy prices

The beginning of June was positive for equity markets, but downtrend still holds, and markets ended the month in negative territory. The US S&P 500 index, which represents major 500 US companies contracted by 8.1% during the month. Similar result was in other developed markets. Except for Emerging markets where result was slightly better with 5.4% contraction. The main factor for such market result was tighter monetary policy than the market expected.

The consumer price index (CPI), the most widely tracked benchmark for inflation, rose 8.6 percent on a year‑over‑year basis in May. The core CPI – which strips out food and energy costs – rose 6% year‑over‑year in May. It shows that an increase in energy price influences inflation by less than 2.6 percent in the United States. Different picture is in the Euro area where inflation rose to 8.1% where the energy price component is much more significant and equals to 3.9%, which is almost half of the inflation. The US is in a better situation trying to stabilize inflation. Europe is heavily dependent on imported energy resources. Therefore, ECB is not rushing to start increasing interest rates.

“With these levels of inflation and inflation being more and more broad‑based, with wages growing in the euro area, we should move decisively toward monetary‑policy normalization,” said Gediminas Šimkus, who heads Lithuania’s central bank. Risks to the outlook for prices are skewed to the upside, he said. Baltic countries experience the biggest inflation in Eurozone area.

Annual inflation rates (%) in May 2022

Source: Eurostat

The US Federal Reserve Bank (FED) made a historical move and raised interest rates by 75 basis points. It is the biggest rate hike since 1994. Also, FED Chair Jerome Powell indicated that another 75 or a 50 basis point move would be on the table at the next meeting. Policymaker intensifies a fight to contain elevated inflation. The goal remains to control inflation without inducing the recession. To reach a “soft landing” – to control the inflation without moving the economy into recession is going to be very challenging. It has been significantly more challenging to cool the hottest price pressures in 40 years due to the tensions in the Eastern Europe and rising commodity prices and further problems in supply chains.

Financial market participants impatiently waited to see if the European Central Bank (ECB) would raise the interest rates. ECB did not make such a decision after more than a decade of ultra‑loose monetary policy. But indicated that a quarter‑point increase in interest rates next month is very likely and opened door to a bigger hike in the fall. ECB president Christine Lagarde said at the end of the month that policymakers are ready to step up their actions to tackle record inflation. There is a strong message that 25 basis points increase in interest rates is on ECB table. Governing Council member Martins Kazaks mentioned a possible larger move during the July meeting.

“House view” update

Luminor Investment management team decided to maintain lowered risk allocation budget and higher exposure to defensive sectors (utilities, healthcare and energy). Also, team allocated part of equity exposure to Consumer Staples sector. Various factors, including high uncertainty about possible consequences of the war in Ukraine, tightening monetary policy, high volatility in the markets and slowed economic growth substantiate such decision.

Luminor House View

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