The euro zone has an annual inflation of 5.3%. For once, both general inflation (which measures inflation in all products) and underlying inflation (which ignores fresh food and energy) coincide. Interest rates in the euro zone are at 4.25%.
Since the highs in November, when inflation reached 10.6%, the reduction has been notable. Inflation has been reduced without rates exceeding it, which is very positive for the economy, because a good part of the rise in inflation was due to problems with the supply of goods, which caused their prices to rise.
The problem is that, currently, we cannot count on inflation to reduce except as a result of the combination of three factors:
That central banks maintain interest rates at the current level.
That central banks raise or maintain interest rates and withdraw money from the market.
Measures 1) and 2) will damage the economy, and will lead us headlong into a crisis (or worsen it if, as some analysts maintain, we are already in recession).
3.That we suffer an economic crisis, in which case it is normal for inflation to fall. A relatively rare situation may arise in which inflation and recession coincide (= stagflation). But we are going to be optimistic and we are going to assume that, if this situation occurs, it will be short-lived.
The ECB's dilemma is the following: according to most analysts, either we are in a recession or we are going to enter a recession in a very few months. Keeping rates high or raising them will allow us to reduce inflation, but will make the recession worse. Lowering rates will help the economy weather the recession better, but it will make inflation worse.
From the point of view of central banks, inflation is a long-term problem, and recession, a short-term one. Past experiences make them believe that it is easier to deal with a recession than inflation when it runs amok; Therefore, we can count on them to continue maintaining rates at current levels (or even raise them if they consider it appropriate). Provided, of course, that they resist political pressures: there is nothing like a recession to bring down the popularity of a government, since the increase in unemployment is very detrimental to the party in government.
At this time, most analysts consider that the Central Banks will make one more rate increase at most. The factor that will most influence whether the increases continue or not is inflation: if it rebounds, we will have a rise in rates, unless an economic catastrophe makes it advisable to lower rates.
For holders of public debt from solvent countries, the best thing that can happen is that they have a portfolio loaded with long-term debt when the crisis begins and the recession forces central banks to lower rates. Then they will have public debt that offers rates higher than those that can be found in the market. And, as a consequence, the value of your portfolio will rise.
For those who like to invest in the stock market, a rate increase followed by rates remaining at high levels is usually, according to historical patterns, very negative for the stock market. It is advisable to stay away from the bags in these circumstances.
The H&B team.