Parameta Logo
parameta logo

UK and US Inflation Battle

Bernard Mutitu
By Bernard Mutitu , Senior Product Manager May 17, 2024
UK and US Inflation Battle


A mixed bag for interest rates: Stubborn inflation, reasons for optimism, and geopolitical risks

All the signs were pointing towards interest rate reductions as inflation came back under control in the US and UK, but recent figures have shown that the level remains stubbornly high. However, it’s a different picture on the opposite sides of the pond.

In the US, inflation grew more than expected in March, blamed on high mortgage and rent costs and surging gas prices. US consumer prices jumped to a 3.5% increase for the 12 months ended in March, according to Consumer Price Index data from the Bureau of Labor Statistics, up from 3.2% in February and marking the highest annual gain in the last six months.[1] Markets anticipate that the Federal Reserve will keep interest rates high until at least September in response.

In the UK, inflation fell to 3.2% in March, its lowest level in two and a half years, but still shy of the anticipated drop to 3.1%.[2] The figures show that consumer prices are still rising, just at a slower rate than last year, and real wages are still rising.

Slowing, but not fast enough

Price gains are proving much stickier in both countries than governments hoped for. This makes picking the right time to reduce the costs of borrowing increasingly difficult. If interest rates remain high, they risk adverse impacts on corporate spending and investment, with knock-on effects for stock market valuations. But central banks don’t want to turn the taps back on until they’ve tamed inflation to their targets of 2%.

US stocks fell sharply on the day inflation data for March came in. The Dow closed 422 points, or 1.1% lower. The S&P 500 lost 1% and the tech-heavy Nasdaq Composite fell by 0.8%.[3]

In the UK, the delicate balancing act for the Bank of England is in full flow. Reaction to the fall in March inflation was jubilant, with investors expecting two interest rate cuts to follow. This drove the FTSE 100 to a record closing high of 8,023 points on 22 April, followed by a new record on 23 April of 8,044.[4] That number was a fall from an earlier intraday high, however, after the Bank of England’s chief economist Huw Pill indicated that he believed rate cuts were still some way off.

The interplay between the countries raises interesting possibilities for market participants. There’s a good chance that the Bank of England drops its interest rates before the Federal Reserve across the pond, while at the same time, the pound is weakening because lower interest rates mean lower returns on investment.

A murky picture

Despite the optimism in the UK, the picture on prices is no clearer there than in the US, there are still marked uncertainties.

UK grocery price inflation, for example, fell to a 30-month low in April, pointing to a potential easing of the cost of living crisis.[1] But insurance costs, one of the drivers of US inflation, continue to rise. The Association of British Insurers (ABI) put the average increase for car cover in the UK at 34% to the end of 2023, for example, with many drivers experiencing far higher hikes, particularly for electric vehicles (EVs).[2]

Both countries are also keeping a watchful eye on geopolitical developments in the Middle East and their potential impact on energy prices. While a spirit of optimism seems to be prevailing in the UK so far, given that there’s been no escalation so far, it remains a key risk.

While plenty of market observers are willing to stake their claim to the number of rises they expect this year in the UK and the US, there remain many scenarios, including reasonable assumptions as well as outliers, that could throw off predictions.

Managing the uncertainty Last year Parameta Solutions, the data and analytics division of TP ICAP Group, the world’s largest inter-dealer broker, launched its Interest Rate Swap Volatility (IRSV) indices which provide market participants with a model-free measure of spot implied volatility in the major interest rate swap markets. Derived from unparalleled access to interest rate swaptions market data, the index consolidates all the volatility information at a specific tenor/expiry into a single measure of implied volatility.

IRSV is a model-free measure of implied volatility, and, as a recent BIS working paper[3] found, predictions of interest rate swap volatility based on model-free implied volatility have superior predictive power over other commonly used volatility forecasting measures.

With IRSV indices, market participants have a greater chance of taking advantage of favourable interest rates and managing the volatility of not knowing exactly when they’re going to arrive.

[1] [2] [3] [4] [5] [6] [7]

This communication and all information contained in or attached to it (including, but not limited to market prices/levels and market commentary) (the “Information”) is for informational purposes only, is confidential, may be legally privileged and is the intellectual property of one of the companies of TP ICAP plc group (“TP ICAP”) or third parties. The Information is directed to Eligible Counterparties and Professional Customers only and is not intended for Retail Clients (as each term is defined by the rules of the Financial Conduct Authority or equivalent). The Information is not, and should not be construed as, an offer, bid, recommendation or solicitation in relation to any financial instrument or investment or to participate in any particular trading strategy. The Information is not to be relied upon and is not warranted, including, but not limited, as to completeness, timeliness or accuracy and is subject to change without notice. All representations and warranties are expressly disclaimed. Access to the Information by anyone other than the intended recipient is unauthorised and any disclosure, copying or redistribution is prohibited. The Information and any opinions expressed within it are not to be relied upon as authoritative, or taken in substitution for seeking your own advice or the exercise of your own commercial judgment. The Information has no regard to specific investment objectives and does not comprise investment advice. The Information is not, and should not be construed as, an offer or solicitation to bid, sell or buy any product, investment, security or any other financial instrument. TP ICAP does not promote any of the contents of the Information. TP ICAP does not make any representation or warranty, express or implied, as to the accuracy, completeness or correctness of the Information, which is subject to change without notice. TP ICAP does not accept any responsibility or liability for any direct or indirect loss or damage, howsoever caused, arising from or in connection with the Information. In no circumstances may the products referred to herein be used for any purpose that would cause it to become a benchmark for the purposes of (a) the Regulation (EU) 2016/1011, (b) the UK version of Regulation (EU) 2016/1011 as on shored via the European Union (Withdrawal) Act 2018 (the “UK Benchmarks Regulation”) (c) other applicable benchmark regulation and/or (d) the IOSCO Principles for Financial Benchmarks in each case together with the relevant technical standards, whether by the products referred to being referenced in a financial instrument, financial contract or investment fund or otherwise. (“Prohibited Use”). The terms of this disclaimer are governed by the laws of England and Wales. For further regulatory information and our terms of business, please see ©TPICAP 2024


Request Follow Up
Speak to our team