Energy Price Hikes and Inflation Further Converge​

By Jake Rickman​

What do you need to know this week?

For the past several weeks, the themes of inflation and surging energy prices have featured quite prominently in TCLA commercial news topics. The latest forecast from the UK Office of National Statistics (ONS) demonstrates how these two macroeconomic trends are highly interrelated when it reached its troubling conclusion that the UK government’s limited intervention of supplying each UK household with £400 will not lower inflation.

Since the government’s announcement last month that all households would receive a one-off payment, the ONS, which is responsible for publishing statistics on the state of the economy, has been trying to determine how it should treat the payment. That is, do the payments constitute effective price cuts to energy bills? In which case, the effect is that inflation, which is ultimately a measure of how much prices are rising, slows. Or do the payments count as increases in household income? To the consternation of the market, the ONS has concluded that the payments are the latter.

While there have been bouts of market optimism this summer, as Europe and North America look towards fall and winter, inflation is expected to climb higher still. The ONS’s conclusion has not helped in this respect.

Why is this important for your interviews?

The fortitude of the market in the coming months depends largely on how central banks will react to the threat of inflation. The consensus from the Jackson Hole symposium, which we reported on last week, seems to affirm the commitment of central bankers to fight inflation by pressing on with rate hikes.

The market is not happy. In the past month, as the Financial Times reports, yields on short-term government bonds in Europe and North America have climbed, which suggests that institutional investors and banks are avoiding short-term bonds because they are betting on future interest rate rises in the near future.

The UK government bond market — also called the gilt market — has been particularly volatile, evidencing the market’s perception about the future of the UK economy. Goldman Sachs now predicts the UK is almost certainly headed for a recession.

How is this topic relevant to law firms?

In the present economic circumstances, companies with floating rate interest obligations such as interest owed on their corporate bonds will want to minimise their exposure to future interest rate hikes. One of the most effective ways to do this is to enter into a contract on the derivatives market that gives them the benefit of a fixed interest rate in exchange for paying a premium.

Thus, derivatives and structured finance legal teams, which advise companies, banks, and other parties with substantial credit and interest rate exposure, are quite attuned to interest rate volatility.

Law firms with stand-out derivatives and structured finance teams include Allen & Overy and Clifford Chance.