Central banks grapple with stubborn core inflation: What it means for markets

Central banks worldwide are facing the challenge of elevated core inflation. Last week, the Bank of England raised rates by 50bps to 5% due to persistently high core inflation at 7.1% y/y, triple its target.

The ECB is also struggling with core inflation, with the eurozone’s reading at 5.3% y/y.

Similarly, the US core inflation exceeds the headline figure, standing at 5.3% y/y, double the Fed’s target. Australia and Canada also experience high core inflation at 6.6% and 4.1% respectively.

This means that central banks are likely to follow the Fed and keep hiking interest rates until the core inflation print starts moving decisively lower.

What does it mean for markets?

As a result, central banks are likely to continue raising interest rates until core inflation starts to decline significantly. This shift towards higher rates may lead investors to favor bonds over stocks, particularly if the US enters a recession. The allure of a 10-year treasury yield above 3.5% makes bonds more attractive.

This is a view reinforced by the Bloomberg MLIV Pulse survey that sees Government bonds performing better than stocks, commodities, and corporate bonds in the second half of this year.

Considering the challenges of managing core inflation, the recent surge in US stocks may be approaching a short-term peak. This is a narrative investors will be carefully considering as inflation becomes more stubborn.

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