Stock markets keep hitting record highs. Is it sustainable, and are UK interest rates about to rise?
19 Oct, 1970
Question by Boring Money reader
Answered by Karen Ward
Markets keep reaching new highs, but government borrowing is climbing and inflation is back on the rise. We asked Karen Ward, Managing Director at J.P. Morgan Asset Management and Chief Market Strategist for Europe, Middle East and Africa, whether the rally is sustainable and whether the Bank of England will raise The amount that a lender charges someone for taking out a loan or a mortgage. It's calculated as a percentage of the amount borrowed - for example, 3%..
Is the stock market rally sustainable?
I do. Now, will it always go in a straight line? Probably not. But markets should go up every year, even in economic theory, because every year economies grow a bit, and the stock market should be representative in some way. Sometimes it is and sometimes it’s not, but it should be linked to the size of the global economy.
Generally, the global economy is always growing a bit, sometimes by a lot, sometimes by not very much, so it should be that we have a new record high every year. So I think seeing new highs shouldn’t worry people.
Is UK economic growth being fuelled by debt?
But why is the economy growing, and is that sustainable, is a very valid question to ask. It’s also very valid to think about whether this is fuelled by debt, and whether that’s unsustainable.
Now, actually, household debt hasn’t been rising and corporate debt hasn’t been rising. In fact, here in the UK, our private sector is in amazing shape. You hear all this doom and gloom, don’t you, about the UK economy and how awful it is. But actually, the household sector has got the lowest debt that it’s had since 2002. And our corporate sector, all of our businesses out there, have got the lowest debt that they’ve had since 1998.
So there isn’t loads of debt in the private sector. It’s government debt where the problem is. Government debt has been rising, and it’s also rising really quickly in the United States. So that is where we need to be a little nervous: how much is debt rising, and how much pressure does that start to put on global interest rates?
We have seen interest rates rising, with government bond yields reaching the highest level they have in a couple of decades. That is because governments around the world are borrowing a lot of money. They are spending it, and at the moment it’s turning up in growth. So that’s why the stock market’s OK and is still quite happy, unless they try and push the bond market too hard.
The bond market was upset last week, and I think one of the reasons was because the president was talking about $5,000 for each American individual if the Republican Party wins the midterm elections.
How does government borrowing affect the bond market?
All governments today are spending more than they receive in tax receipts. That’s called the government deficit, which is basically the government being in its overdraft every single year.
The government can get hold of that money by issuing debt, by issuing A type of asset that represents a loan, usually issued by a government, company or agency that wants to raise money to fund its operations. It goes out into the market and says, ‘Here’s a piece of paper, a bond. In 30 years’ time I will pay you back the principal, and in the interim I will pay you a rate of interest. So you’ll get some income, you’re happy, I get my money and I can go off making my electorate happy.’
Some governments find it really easy. The US is a big economy, a strong economy, with very liquid markets, as financiers would say, which just means you can buy and sell this stuff pretty easily. They usually find it a lot easier to borrow from the world than countries like us here in the UK, where global investors don’t have to buy UK government bonds if they don’t wish to. There’s often not a reason to, so we are a little bit more vulnerable to some of the choices that we make.
But overall, it’s simply about each government wanting to spend more money than they’ve got, and having to go to the global economy, to global savers, and say, ‘Could I have a bit of money, please?’
Do you think interest rates here are going to go up? We’ve seen them go up in the States. Is it likely we’ll follow suit?
I think we probably will see the Bank of England raise interest rates, probably in November. What’s happening in the UK is like everywhere else in the world: oil prices are rising. We all feel that. If you filled your car up at the weekend, you certainly know that. And that is pushing up inflation, and the central bank’s job is to try and controlTerm used to describe how quickly the prices of goods and services is rising over a period of time. In periods of high inflation, prices are increasing rapidly, whereas low inflation means prices are increasing by only a small amount..
But the Bank has been in a slightly different position to some of the other central banks, because our economy has been a bit weak. When you’re a central bank worrying about prices rising, the reason for raising interest rates is if you worry that those price increases are going to get really embedded in the economy.
What is a wage-price spiral and why does it matter for interest rates?
Your petrol price goes up, so you go and ask your boss for more pay to compensate you. But then your company’s wage bill and energy costs have gone up, so they raise their prices again, and we get into this wage price spiral. There hasn’t been much evidence of that in the UK, because our labour market’s been really soft for the last 18 months.
So the Bank of England have been umming and ahhing. They can see that headline inflation’s going up, and inflation hasn’t been at their 2% target for some time. So they want to show that they care about inflation and that they’re going to bring it down. But they’re worried that if the economy is already weak, they’re going to kill it. Rising oil prices and higher mortgage costs could cause an unnecessary slowdown.
So they’re in a really tricky position. I have to say, I don’t envy them that job at the moment. But the latest data suggests the economy is probably strong enough, and they’re feeling the pressure. Inflation’s probably going to be over 4% again early next year, and that’s twice where it should be.
This article is for information only and is not financial advice. The value of investments can go down as well as up and you may get back less than you invest.
