Market Commentary: Week to 16 May 2023

Market News

The Bank of England ("BoE") raised interest rates as expected last week by 0.25% to 4.50% as policymakers voted 7-2 to increase borrowing costs to the highest levels since 2008. This marked the twelfth consecutive hike by the BoE as sticky inflation has proven difficult to shift, forcing its hand to further raise rates. Banks are now pricing in a rise to 4.75% this year but many economists believe that it will peak at 4.50%. The persistence and strength of food price increases led the central bank to admit to underestimating the persistent high inflation and has resulted in it raising its inflation forecast. The updated projections see inflation slowing to 5.1% by the year-end compared to previous forecasts of 3.9% in February. The BoE also revised forecasts for economic growth with an expectation of zero growth in the second quarter compared to a 0.7% contraction.

News in the US was largely dominated by ongoing negotiations regarding the debt ceiling crisis. The US breached its debt ceiling in January 2023 and the Treasury Department has been using extraordinary measures to provide the government with more cash while it figures out what to do. The cap currently stands at roughly $31.4 trillion and the breach of this level has spread fears of a potential default by the US. Usually Congress raises the limit but it appears terms cannot be agreed at present this time around. The views of Republicans and Democrats differ quite significantly when it comes to debt. Republicans have a sceptical view towards debt and see rising national debt as evidence of an out-of-control government. Whereas Democrats view national government power as a force for good and see raising the debt limit when needed as necessary housekeeping to maintain the operation of the government.

If the debt ceiling is not raised then the outcome is not entirely clear as these are unprecedented circumstances. However, if it led to the US defaulting, it would likely lead to major economic damage. The last time the US was seen at a serious risk of default was in 2011. Talks went down to the wire before a compromise deal was reached which included $900 billion in spending cuts over 10 years. There appears to be several different options available in order to raise the debt ceiling, but it looks likely that negotiations may go down to the wire again. Therefore the probability of a default appears to be low at present as negotiations continue in order to achieve a suitable compromise.

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