Investors bet on more aggressive rate hikes after US inflation shock

Stock markets around the world tumbled after inflation in the United States surged to the highest level for more than 40 years – paving the way for a series of aggressive interest rate hikes. 

As the outlook for the global economy darkened amid fears of a dangerous bout of stagflation and recession, the FTSE100 index fell 2.1 per cent, or 158.69 points, to 7317.52 and the FTSE250 was down 2 per cent, or 400.08 points, to 19673.32. 

That wiped £50billion off the value of Britain’s leading companies. The losses were mirrored in Europe where the main benchmark in Frankfurt sank 3.1 per cent, while Paris was down 2.7 per cent and Milan 5.2 per cent. 

Wall Street also opened sharply lower with the Dow Jones Industrial Average down 2.6 per cent, the S&P 500 off 2.7 per cent and the tech-dominated Nasdaq 3.3 per cent lower. 

The transatlantic rout came after official figures in the US showed inflation jumped to 8.6 per cent in May, up from 8.3 per cent in April, as rising energy and food prices stoked the cost of living crisis sweeping the world. Inflation is at its highest level since December 1981 when Ronald Reagan was in the White House and Margaret Thatcher resided in Downing Street. The figures sent shockwaves through trading floors in financial centres worldwide and dashed hopes that inflation in the US had peaked. 

The dollar soared against currencies around the world as investors bet on a string of rate hikes by the US Federal Reserve, the central bank. 

Government borrowing costs also rose with bond yields up in the US, UK and across Europe. Brian Nick, chief investment strategist at asset manager Nuveen, said investors are growing increasingly worried that the scale of interest rate hikes required to tame inflation ‘increases the risk of recession’. 

Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, added: ‘Inflation is what’s scaring the horses on financial markets. The cheap money journey is hurtling abruptly to an end.’ 

Inflation in the US fell from its previous 40-year high of 8.5 per cent in March to 8.3 per cent in April and investors were hoping this meant the worst was passed and the Fed may not have to raise rates so abruptly. 

But Ryan Detrick, chief market strategist at financial advisers LPL in the US, said the inflation surge last month was ‘another black eye for the market’, adding: ‘Hopes for a peak are dashed.’ 

The figures fuelled expectations the Fed will be forced into a series of aggressive interest rate hikes in a desperate bid to get inflation back under control. 

Economists said the Fed may even raise interest rates by 0.75 percentage points – or 75 basis points in City speak – when it meets next week. Further rises of 0.5 percentage points are expected in July and September.

The surge in inflation around the world has sparked a cost of living crisis that poses a political risk to both Prime Minister Boris Johnson and President Biden. 

Inflation in the UK is already running at a 40-year high of 9 per cent and looks set to top 10 per cent later this year. It is also at a record high in the eurozone of 8.1 per cent.