In the third quarter of this year, we finally saw a notable decline in UK inflation, which allowed the Bank of England to ease off on their counter-inflation measures, with the base rate only rising 0.25% across this quarter.

Other key points include:

  • UK Corporate bonds have been the strongest performing asset class within Q3.
  • It is likely we have reached or nearly reached the peak of interest rates; however it is predicted they will stay higher longer than previously foreseen.
  • Japan has stood out with exceptional performance in terms of interest rate levels, currency movements, and equity returns, which once again reminds us of the importance of global diversification.

UK Inflation and Interest Rates

One of the standout features of the last quarter has been the noteworthy decline in UK inflation. Over this period, UK inflation fell by 2% to 6.7%, surpassing expectations. This welcome drop allowed the Bank of England to hold rates steady at 5.25% during its September meeting, following a modest 0.25% rate increase earlier in the quarter.

This development provides investors with valuable insights into the central bank’s approach to managing interest rates, suggesting the Bank of England will prefer to hold rates steady, rather than increasing them to a sharp peak. While this allows the consensus to believe we’ve reached the peak of interest rates at 5.25% or 5.50%, it does mean it is likely we will stay at these elevated levels well into next year.

Global Equity Markets and Corporate Bonds

Global equity markets began the quarter on a strong note, ultimately delivering a small positive return. In the UK, corporate bonds performed exceptionally well, generating a notable 2.3% return, making them the strongest performing asset class in Q3. This trend favored lower-risk portfolios, which outperformed their higher-risk counterparts. However, global bonds and emerging market bonds fell slightly.

In terms of UK equities, they also exhibited resilience compared to other regions, driven by the FTSE’s substantial exposure to the Energy sector, which benefited from higher oil prices. In addition, Japan maintained a strong performance, while other equity regions faced challenges due to a weak Chinese economic outlook and higher US bond yields.

The Bank of Japan and the Importance of Global Diversification

The Bank of Japan have spent decades trying to deter a deflationary environment and therefore are now cautious to deter any inflationary pressures. Consequently, the Bank of Japan chose to employ an ultra-loose monetary policy, featuring negative interest rates and yield curve control, often referred to as “Quantitative Easing infinity”. As low interest rates encourage investors to leave their money elsewhere, this has weakened the yen which has fallen by around 15% so far this year.

Therefore, instead of copying the sharp interest rate hikes we have seen elsewhere, the Bank of Japan’s supportive policy and the weaker yen boosting exporter’s earnings has meant Japan equities are up around 25% so far this year in local currency terms and their inflation peaked at only 4.3%.

This case study on Japan serves as a poignant reminder of the importance of global diversification for investors as not all economies move in lockstep. Diversifying your investments globally can help you navigate varying economic conditions and market performances more effectively.

If you have any questions on any aspects of this update, contact your adviser for more details.