FTSE 100: 7682.27 ▲ 125.83 (1.67%)
Investors are overlooking the pace of inflation's fall, which could avert a second interest rate rise this year and provide a boost to the sluggish UK economy, according to JPMorgan’s Mike Bell.
The latest figures from the Office of National Statistics (ONS) shows consumer price inflation fell to 2.5% in March, down from 2.7% in February. Juts four months before, inflation was at a five-year high of 3.1%.
‘What is being under-appreciated is the pace at which inflation has fallen,’ he said, adding it could fall below the Bank of England's 2% target before the year was out.
‘We could see a drop back below target by the end of year, and that is under-appreciated by both the market and investors.’
Falling inflation marks an end to the year-long pay squeeze that has dogged consumers. Figures released by the ONS on Tuesday showed wage growth hitting 2.8% in the three months to February, finally outpacing inflation.
‘There has been a very pessimistic view of the UK high street and consumers, and that is the reason UK growth has been stuck in the doldrums,’ said Bell. ‘But that [pessimism] could be at a nadir, and we could see more of an improvement than most people expect.’
An uptick in wage growth and the economy could put the Bank of England’s expected November interest rate rise at risk.
Bell said that the Bank ‘will put [rates] up in May but November will be put into question if inflation falls quickly’.
‘To us the upside risk to the UK comes from inflation falling faster than expected. The downside is a slowdown in housing but if interest rates go up slowly because of the fall in inflation then we hope that benefits the housing market,’ he said.
While Bell is predicting fewer UK rate rises than the market, he believes one more than anticipated will happen in the US.
He said markets were currently pricing in three US Federal Reserve rate hikes this year, but ‘we think they will do four, but it’s 0.25% we are arguing over and it is hard to see one extra rate rise causing problems this year’.
However, he said the economy could be impacted next year as he believes the Fed will raise rates three times ‘but the market is pricing in one so there is more room for adjustment’.
‘It is hard to see recession risk in the US in 2018 but we are late cycle and the risk is tighter monetary policy,’ he said.
Bell said that the market wobbles earlier this year showed investors were alert to the risks of higher inflation. In the US, higher wage inflation would cause the Fed to tighten monetary policy but Bell expects wage acceleration to be ‘moderate’ and therefore interest rates should not cause too much of a problem for stock markets this year.
He added that historically, equities had not come under pressure until the yield on US two-year Treasury rate was above 3.5%. It currently stands at 2.4%.
‘Flattening of the yield curve is one to watch,’ he said. ‘Historically, the two-year Treasury yield curve has risen above the 10 year Treasury yield prior to recessions. While the curve has flattened in recent years, it hasn’t inverted yet.
‘Importantly, equity markets have historically only peaked after the curve has inverted and often quite some time after.’