A recurring theme in markets, and these Trades articles, this year has been inflation. Why have we been obsessing about demand spikes, supply chain bottlenecks, labour shortages and the definition of ‘transitory’? Because almost every recession in the US in the past 50 years began with an inflationary squeeze. Inflation itself does not cause a recession, but the blunt tool of higher interest rates used to dampen an overheating economy, invariably does.

 Norway was the first major central bank to raise rates in September, followed closely by New Zealand. Then the Governor of the Bank of England, Andrew Bailey, indicated that a first hike in interest rates could occur in the UK as early as next week’s ‘live’ meeting of the Monetary Policy Committee. Meanwhile, the US is behind even the ECB in starting to taper its QE programme, let alone raising interest rates.

So why is the UK looking to follow Norway’s example and raise rates when the US and ECB are not? It is not as if the economic horizon is free of dark clouds.

For supporters of a rate hike, the strategy is akin to a car (the economy) approaching a sharp bend in the road (rampant inflation). An early rate hike is a touch on the brake pedal; it slows the car and allows a better judged brake closer to the bend. It also reduces the risk of having to slam the brakes on too late and the car ending upside down in a ditch (recession).

 But perhaps Governor Bailey is taking the Maradona approach to monetary policy (first identified by one of his predecessors, Lord King). This approach is so named after one of the goals that Diego Maradona scored against England in the 1986 World Cup. Not the one he scored with his hand, but the one where he beat five defenders by running 60 yards in a straight line. He could do so because his movements made the England defenders anticipate a change in direction that never came.

 Likewise, by signalling the prospect of higher rates, Bailey has prompted yields in the bond market to rise. And so, he has achieved some of what a rate increase would do, a tightening of monetary conditions, without yet raising rates.

 Whether Governor Bailey is channelling his inner Maradona or not, the path to a higher rate environment has begun. Last week in the US the Federal Reserve Chairman, Jerome Powell, seemed to acknowledge for the first time that he may need to act on rates sooner than planned if inflation persists.

 In the Endeavour Fund we have prepared for this by increasing our exposure to the financial sector. In short, banks are attractive because their net interest margins can expand with higher interest rates, as the strengthening economy should mean their customers are more willing and able to borrow.

 

Maradona was one of the greatest footballers ever. Time will tell if Bailey can emulate him in the world of monetary policy.

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