There’s always one deal that symbolises the end of an era. In the early 2000s AOL’s merger with Time Warner served notice that the dot-com boom was over. Royal Bank of Scotland’s over-priced takeover of ABN Amro was followed by the global financial crisis of 2008-09. The question now is whether Elon Musk’s purchase of Twitter will be seen as the moment the global economy tipped into recession.
The signs are not promising. Even before Musk sealed the deal, tech stocks had seen a sharp sell-off. The stock market value of Meta, the parent of Facebook, fell by $80bn on Thursday after Mark Zuckerberg’s company announced a 50% drop in third-quarter profits. The reason was simple: advertisers are reining in spending in response to slowing global growth.
Some repricing of tech stocks was inevitable as economies opened up again after the Covid-19 pandemic. Facebook, Google’s owner Alphabet and Amazon were winners when consumers were confined to their homes during lockdown and were always going to struggle to keep such high levels of revenue growth as life returned to normal.
There was, though, another reason for rocketing tech stocks: the easy money policies pursued by the world’s central banks. Ultra-low interest rates and purchases of bonds through quantitative easing programmes meant there was plenty of speculative cash to go around.
What’s more, it wasn’t just tech stocks that boomed. Conditions were ideal for an “everything bubble” in which shares, bonds and real estate prices all rose sharply. In recent months, it has become clear that the “everything bubble” is over, pricked by the tightening of policy by central banks in response to higher inflation.
So far, it has really only been shares and bonds that have tumbled. There is, though, evidence that higher interest rates are starting to have an impact on the wider economy. The unwinding of the asset-price boom is about to enter a new and much more dangerous phase as central banks test the ability of their economies to withstand higher borrowing costs.
There is a fear the global economy is approaching breaking point. China’s property meltdown, the emergency Bank of England action to prevent a run on pension funds and the collapse of tech stocks are all part of the same story: a fragile global financial ecosystem coming under stress.
Dhaval Joshi, of BCA research, says 2022 was the year that central banks’ “monster tightening” killed bond and stock market valuations, and 2023 will be the year that this “monster tightening” finally reaches the economy and kills profits and jobs.
That may seem like a curious conclusion given that the recent economic news hasn’t been that bad. The US economy bounced back in the third quarter after six months of falling output, while Germany, France and Spain all expanded modestly. Unemployment rates remain low, with the jobless rate in the UK the lowest since 1974.
The good news won’t last, but while it does it is likely to encourage central banks to keep policy tighter for longer, so they can be sure they have squeezed inflation out of the system.
They won’t say as much but they are prepared to see dole queues lengthen to reduce upward pressure on wages. Higher unemployment will not be accidental.
Some inflationary pressures have weakened. The prices of oil and industrial metals are well down from their peak. Wholesale gas prices were at €350 a megawatt hour in the summer but last week were below €100 a MW/h. Durable goods prices have come down as global supply bottlenecks have eased and demand softened.
These price movements point to a marked weakening in global activity over the coming months. But central banks won’t be satisfied until they see wage inflation falling as well. That’s why the European Central Bank raised rates by 0.75 percentage points last week and why the Bank of England is expected to raise UK borrowing costs by a similar amount when its monetary policy committee announces its latest decision on Thursday.
Threadneedle Street will be making its decision without seeing the full details of Jeremy Hunt’s autumn statement due on 17 November, but will know that the chancellor plans to raise taxes and cut spending. If the rumours are correct, Hunt may suck as much as £40bn out of the economy.
Clearly, this is a critical moment for the Bank. The UK economy probably contracted by 0.5% in the third quarter; wage increases are failing to keep pace with prices; business failures are increasing; consumer confidence is weak; activity in the housing market is declining; and global commodity prices are falling.
Set against that, the annual inflation rate is above 10% and core inflation – the cost of living excluding food, fuel, tobacco and alcohol – is above 6%. Official interest rates are now 2.25% and at the height of the panic after Kwasi Kwarteng’s mini-budget financial markets thought they might climb above 6% next year. The expected peak has since come down but it is still assumed to be about 5%.
The Bank faces the difficulty of not knowing when to stop, but what’s certain is that the peak in rates assumed by financial markets is inconsistent with a soft landing for the economy. Monetary policy works with a lag, so the impact of raising interest rates now will only be felt next year, when inflation will be coming down and unemployment will be going up.
In truth, the Bank of England has probably already done enough to bring inflation back to its 2% target in 18 months to two years’ time. Rates don’t need to go to 5% and if they do the Bank will be guilty of massive overkill.
