A phenomenon that was not seen in Western countries since the late 1980s is once again becoming part of our reality: inflation is back and rounding two digits in some countries.
Driven primarily by the surge in energy and commodity prices and worsened by the war in Ukraine, inflation rates were already on an upward trend due to the expansive monetary policy designed to support the economy against the crises and the supply bottlenecks created by the pandemic.
As all signs point to high inflation over the coming months, the market is starting to adjust to this new environment.
Inflation is soaring
In March 2022, inflation soared to 8.5% over 12 months in the United States and 7.5% in the Eurozone, a record not broken in decades. Among European countries, inflation reached 7% in Germany and Italy, over 9.5% in Spain and the Netherlands and 4.5% in France, where inflation was maintained at a lower level thanks to price caps on certain commodities.
This change of economic paradigm is affecting financial markets. Over the last semester, the yields on government bonds have been rapidly increasing. For example, the yield on bonds at less than 4 years has passed from negative to positive. Check out the evolution of government bonds yield curve per country here.
Central Banks are also adjusting their monetary policies to maintain the stability of their domestic economy. In the US, the Federal Reserve (Fed) has approved their first key interest rate rise since 2018 (+0,25%) and has announced they will continue increasing it up to 1.75%-2% by the end of the year. The key interest rate is the price at which commercial banks can borrow money at when they fall short of liquidity. As money supply becomes more expensive, the credit demand for investment and consumption, which contains inflation, decreases. Although the European Central Bank (ECB) has decided not to raise their benchmark interest rate for now, as this could weigh down on the recent economic recovery, the financial institution has recently indicated that they will conclude their assets purchase program by the end of the third quarter 2022. In this statement, they also declared that “any adjustments to the key ECB interest rates will take place some time after [Q3] and will be gradual”.
Consequently, investors are requesting higher rates to compensate for rising inflation. In particular, commercial banks are starting to echo their higher refinancing cost on the interest rate offered to their clients. In France and the Netherlands, for instance, this increase is estimated to range between 0.50% and 1% in addition to current prices.
Adapting to a new environment
Faced with a changing macroeconomic situation, October is continuously monitoring the markets and adjusting to this new reality.
How? Thanks to the data accumulated since 2014, we now have a better view of companies’ resilience based on their characteristics, behaviours and financial and banking statements. We also have a better understanding of expected returns per asset class and country. This helps us adjust our scoring models, by integrating new criteria or by modifying the existing ones, and reflect interest rates moves into our loan rates.
At October, we commit to a flexible approach, adapting to a changing environment to provide our borrowers, lenders and partners with the best possible service. And we will do it as often as necessary if the situation requires it. In the meantime, the level of inflation we shall experience will depend on the evolution of the war in Ukraine and the policies implemented by Central Banks.