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Financial markets digest inflation data

Key takeaways

The latest US data points to inflation levels last seen in the 1990s, and financial markets are taking notice – but perhaps not to the degree you might expect. Bond markets have reacted accordingly, but stock markets have taken the latest developments in their stride.

  • US inflation data for October indicated to the highest consumer price rises since a brief period in 1990, marking the sixth time in eight months that the reading came in above expectations. Recent gas and oil price rises were in evidence in the numbers, but pressure in pandemic-sensitive sectors (such as used vehicles and airfares) appeared to be falling back in the wake of summer demand. However, other critical costs in the calculation of US inflation – such as shelter (rental) costs – are still rising. We expect monthly inflation data to remain elevated for the time being, but we should see these factors begin to wash out over the coming months.
  • Meanwhile, data from China pointed to lower inflation than among leading developed economies, though this too is rising. Given China’s status as the world’s ‘factory floor’, inflation here is also being exported to developed economies. Supply chain bottlenecks, alongside a resurgence of COVID-19 in some locations (slowing production) are unhelpful factors, but both are expected to fade as supply chains normalise and responses to the pandemic mature.
  • On the whole, financial markets are digesting the latest spate of inflation data, and sending signals through bond market indicators (like the breakeven rate – the difference in yields on inflation-linked bonds versus nominal bonds of the same maturity) that inflation could be higher in the near term. However, medium-term inflation expectations are actually falling. So, while we may need to learn to live with a higher inflation backdrop than in recent years, we should not expect a severe impact on economic health, consumer behaviour, or financial markets. Put simply, we do not anticipate a return to extreme inflation eras like the 1970s.
  • Riskier asset types like shares have taken the noise around inflation in their stride. Stock market investors appear to have signed up to the view that these pricing pressures are largely transitory, meaning that central bank policymakers will not be forced to take drastic measures to contain it. Interest rates are expected to go up (in response to economic recovery, not inflation), but not to the high levels seen in the past. With the real return on cash now even less attractive than it was in the 1970s, staying invested is the only option for many, and financial conditions remain very accommodative.

Weekly market moves

  • In a quiet week for global stock markets, emerging market shares led the way in sterling terms. The shares of mid-sized UK businesses also performed well.

  • Bond markets were weaker, impacted by inflation data.

  • It was a strong week for precious metals like gold.

What to look out for this week

  • More inflation data is due for release this week, including in the UK and Europe.

  • In geopolitical news, Presidents Xi and Biden are due to meet at a virtual summit, while UK and European officials will discuss post-Brexit protocols for Northern Ireland.

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