Whilst the start of the year had brought positivity to markets with evidence that inflation had peaked in many major economies, bringing greater expectations that Central Banks would begin to slow down their interest rate rises, recent weeks have seen inflation remain stubbornly high, especially in the UK.

This has led to interest rate rises and it is predicted that the Bank of England will soon raise rates to 5.75% to attempt to combat inflation. This is bad news for those with debt and looking for a mortgage, but more positive for savers who are now benefitting from some of the highest rates for decades.

Economic Strength and Inflation Concerns:

Economic data showed a robustness to the UK economy, especially in the Services sector. However, inflation data for April showed inflation is also strong which, despite the headline figure falling from the previous month, fell by less than expected and showed an accelerating rate on other measures.

Equity Performance and Caution:

Global equities remained relatively flat due to uncertainty surrounding the US debt ceiling. US equities experienced relief as a deal was reached. The UK market underperformed, namely due to stubbornly high inflation and weaker commodity prices.

Bond Yields, Gilt Prices, and Corporate Debt:

Higher-than-expected UK inflation pushed up bond yields, impacting gilt prices. Short-dated corporate debt was less affected, especially High Yield bonds, which are less sensitive to interest rate changes.

Interest Rate Increase and Cash Returns:

The Bank of England raised interest rates by 0.25% to 4.5% per annum, boosting cash returns further. This is something we examine in more detail in our ‘What is going on with interest rates’ blog post.

Bond vs. Equity:

Bonds underperformed equities, resulting in higher-risk portfolios outperforming lower-risk portfolios during the month.

Other Topical Themes:

US Debt Ceiling Reaches Resolution: In early June, the US Congress reached an agreement to raise the debt ceiling, ensuring that there would be no default on US Treasury Bonds. This resolution came just in time, as a default could have occurred within a matter of days. While a deal was expected, the potential severity of the situation created tension in the markets leading up to the agreement, particularly impacting short-dated Treasury bonds.

The outcome of the deal appears to be favourable for the Democrats, as they only had to make relatively minor concessions on spending reform compared to the large demands made by the Republicans. Once it became clear that a deal was imminent, the market responded positively. However, it’s important to note that the impact of this situation, except in the event of a default, was always expected to be short-term in nature.

Persistent UK Inflation: Released in May, the inflation data for April showed a significant decrease from 10.1% to 8.7%. However, upon closer examination, the situation is not as positive as it initially appears. The drop in inflation was mainly driven by lower energy bills, accounting for 1.4% of the decrease. This means that the entire decline in inflation was due to what is called “base effects,” as the substantial increase in energy bills from April 2022 no longer influenced the data.

When we look at other measures of inflation that provide a better indication of price increases generated within the economy, the picture becomes less encouraging. Core inflation, which excludes energy, food, alcohol, and tobacco, actually accelerated from 6.2% to 6.8%. Additionally, Services Consumer Price Index (CPI), a key indicator, rose from 6.6% to 6.9%. One notable driver of Services CPI was the upward adjustment of phone contracts in the telecommunications sector. The rise in Services CPI, especially, raises concerns for the Bank of England (BoE), as it could potentially signal the beginning of a wage-price spiral.

Following the release of the inflation data, expectations increased regarding how much the BoE will raise interest rates. This led to an increase in bond yields, meaning that bond prices fell. Currently, government bond yields are over 4.5% and almost 5% for very short-dated bonds. This may present an attractive entry point for investors interested in bonds.