There was a very interesting article last Thursday’s Financial Times (3rd July) by George Magnus, Senior Economic Adviser at UBS Investment Bank. The headline took the form of a question “Can raising rates really be the answer to the downturn?” This is an issue we repeatedly come back to – why would a central banker now, at this moment in time, in the developed world, raise interest rates when all about him is in such disarray and the economy is sitting on the edge of a cliff. We are truly amazed that the ECB went so far as to raise interest rates 0.25% to 4.25% today, which implies that it won’t stop there – they are hardly going to cure inflation by raising interest rates only once, unless of course, and we expect this, conditions deteriorate so rapidly that they have no option but to reverse the decision.
The lessons are there for all to see. Japan was greatly criticised for fighting inflation in 1990 by tightening just at the time their stock market was in great peril and at the start of a primary bear market; that bear market for equities and property morphed into a deflationary nightmare. One of the reasons events turned out so badly in Japan, said the patronising economists of the West then, was because the Japanese central bank stupidly raised interest rates when they should have been more concerned about the economy than inflation.
Mervyn King recently said “The Bank of England won’t raise interest rates just to gain credibility and must avoid an economic slowdown that’s sharp enough to pull inflation below target.”
The global economic downturn is going to get worse whatever happens but if central banks across the board start raising interest rates, they may get something much worse – a Japanese-style long term deflationary collapse!
Government bonds enjoy safe haven status in spite of the inflationary fears. Where are the bond vigilantes who should be selling them wholesale, driving prices down and yields up? It seems to us that they are not actively selling and may be instead buying.
UK index linked long-dated gilts continue to enjoy great support. Over the past twelve months the 1.25% I/L 2055s are up over 20% – and here’s a funny thing, nobody is talking about it! It has been one of the most successful investments to hold over the past year, yet nobody is talking about it. It gives further evidence to the unchallengeable truth which is, whatever the economic and investment conditions happen to be, there is always a way to invest money successfully. But you have to do the work and be prepared to act differently to the consensus. At key moments in time, the consensus is never right. Strange to say, investors, in the main, seem to prefer losing money in good company rather than making money on their own.