Q4 Market Commentary – December 2021

Since the pandemic began, policymakers have strived to protect their economies from the impact of lockdowns. Central banks cut interest rates to record lows while governments announced various stimuli and support packages, all designed to prevent long term damage to their respective economies. As 2021 began, inflationary pressures started to rise but economic growth was deemed to be more important than the threat posed by inflation. It was only as the year came to an end, that central banks looked ready to address the inflationary pressures.

The standard policy response to increasing inflation is to increase interest rates. As money becomes more expensive to borrow, this encourages people to save more and spend less, lowering the demand for goods and services, reducing price increases.

In December, the Bank of England broke ranks and became the first central bank of a major economy to announce an increase in interest rates since the start of the pandemic; up 0.15% to 0.25%, from an historic low of 0.1%. The decision followed a surprisingly sharp increase in inflation to 5.1% during November, up from 4.2% in the previous month, well ahead of the Bank's forecast that inflation would "comfortably exceed 5% when the Ofgem cap on retail energy prices is next adjusted, in April". Further pressure to act was applied by the International Monetary Fund in its annual report on the British economy, which warned the Bank of England not to act too slowly to avoid “inaction bias”. Markets reacted somewhat with surprise to the increase, given the recent emergence of the Omicron variant and its potential impact on the economic recovery.

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