EN - Business (Newsletter) - Flipbook - Page 10
LIONTRUST
WHY INFLATION
AND INTEREST RATES
in developed markets matter
This year is set to be pivotal in terms of economic drivers. The world has seen
several years of subdued inflation, record low interest rates and unprecedented
levels of government financial support for markets and the economy in the form of
Quantitative Easing (QE).
QE involves central banks increasing the supply of money and
buying bonds to support the markets and the economy.
Inflation and interest rates will be more significant gamechangers in 2022 as policymakers must guide the world
through its recovery from the pandemic.
Governments’ monetary policies determine interest rates. They
can raise interest rates to dampen overheating economies and
stifle inflation. This happens because higher interest rates attract
money out of the economy into bank deposits and makes it
more costly for companies to borrow, undermining the business
environment. The opposite effects occur when governments
reduce rates to boost flagging economies.
But why will this matter to investors?
INTEREST RATES ARE KEY
The most important reference points for financial markets are
interest rates.
Central banks such as the Bank of England and the European
Central Bank will lend money to commercial banks at what are
known as ‘base rates’.
These rates are the starting point for the business conducted by
banks. The interest they offer on their deposit accounts and the
interest they charge on mortgages are linked to their domestic
base rates.
Central banks will regularly announce updates on their base
rates. The Bank of England announces its rate each month after
a meeting by its Monetary Policy Committee, for example.
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THE IMPACT ON ASSETS
Higher interest rates – which are likely in 2022 – impact the
prices of financial assets negatively.
Companies will be hit by the tougher business environment
weighing on equities, which, together with bonds and real
estate, will also be less attractive to investors who might be
tempted to put more of their money into cash deposits.
Central banks in the US and the UK are expected to raise their
base rates in 2022 and to taper their QE programmes. Financial
markets have priced in expectations that the UK, for example, will
have raised the interest rate to 0.5% by the spring
and to 1% by the end of 2022, while a
Financial Times survey of leading
economists predicts US rates
will begin rising in Q2.
