Gold rose and the dollar fell in mid-December after the US central bank decided to wind back its stimulus measures.
In the UK, the decision by the Bank of England on December 16 to raise interest rates to 0.25 percent from their historic low of 0.1 percent, which surprised some market commentators, boosted the pound, improving the affordability of gold for savers.
The US Federal Reserve’s move to reduce stimulus measures was a response to a recovery of the world’s largest economy during the pandemic and a pickup in inflation.
Expectations of rising interest rates in the United States in 2022 could drag on prices of gold, which bears no interest, as alternative yield-bearing assets will become more attractive to investors.
However, the persistence of inflation, running at an annualised level of 6.8 percent in the United States, its highest rate for around 40 years, will continue to underpin gold, which is seen as a hedge against rising prices.
“Unless the Fed eventually goes for much bigger rate increases than expected, the general public will be stuck in a negative real rate position where inflation increases are higher than those of interest rates being received. In theory that tends to be positive for gold,” wrote Lawrie Williams, gold market commentator for bullion dealer Sharps Pixley.
“But a more aggressive rate policy also tends to increase the dollar index, which is seen as negative for the gold price, although initial reaction was for the greenback to fall back, but only by a little.”
In Britain, the rise in the pound could be supported by expectations of further rate rises, with some analysts predicting another hike of some 15 basis points when the Bank of England’s rate-setting committee meets in February.
The latest inflation data, showing a 5.1 percent annualised rise in prices in November, the highest level in more than a decade, had raised expectations that the UK central bank would hike rates despite worries over the impact of the fast-spreading Omicron coronavirus variant on the economy.
The latest data showing that employers had hired a record number of staff, had also raised expectations that the Bank of England would raise rates.
A stronger pound against the US dollar, may make it more affordable for UK-based savers to add to their gold holdings, with projections of persistent inflationary pressures set to add to the allure of gold as protection against rising prices, with the authorities predicting that UK inflation could hit 6 percent in April.
Frequently asked questions
Why did the price of gold increase and the US dollar fall in mid-December?
Gold prices experienced a rise and the US dollar fell in mid-December following the decision by the US Federal Reserve to reduce its economic stimulus measures. The central bank made this move in response to a steady recovery in the United States economy during the pandemic, alongside a noticeable pickup in inflation rates.
However, despite the reduction in stimulus, inflation in the US has remained exceptionally high, running at an annualised level of 6.8 per cent, which is the highest rate observed in about forty years. Because gold is traditionally seen by investors as a reliable hedge against rising prices, this persistent inflation continues to underpin and support gold prices. Additionally, the initial market reaction to the Federal Reserve’s policy announcement actually caused the greenback to fall back slightly, which helped to boost the precious metal.
How does the Bank of England’s interest rate rise affect UK gold buyers?
The Bank of England’s decision to raise interest rates to 0.25 per cent from its historic low of 0.1 per cent has boosted the value of the pound, which improves the affordability of gold for UK-based savers. Because gold is globally priced in US dollars, a stronger British pound against the greenback means that domestic buyers and savers can purchase more gold for their money.
While rising interest rates typically make yield-bearing assets more attractive than non-interest-bearing gold, the current environment of high inflation means real interest rates remain negative. With UK inflation having risen to an annualised 5.1 per cent in November, and projected to potentially reach 6 per cent by April, the appeal of gold remains strong. The stronger currency coupled with persistent inflation makes adding to gold holdings an attractive option for protection against rising prices.
What is the outlook for UK interest rates and inflation in the coming months?
The outlook points towards further interest rate increases and elevated inflation in the United Kingdom. Following the surprise rate hike to 0.25 per cent in December, many market analysts are predicting another rate increase of approximately 15 basis points when the Bank of England’s rate-setting committee meets in February.
This expectation of tighter monetary policy is driven by strong economic data, including employers hiring a record number of staff and high inflation figures. Annualised inflation reached 5.1 per cent in November, marking the highest level the UK has seen in more than a decade. Authorities are currently predicting that this inflationary pressure will persist, with the inflation rate potentially climbing as high as 6 per cent by April. These factors are expected to maintain the appeal of gold as a protective asset.
Could rising interest rates in the United States drag down gold prices?
Yes, expectations of rising interest rates in the United States in 2022 could potentially drag on the price of gold. Because gold is a physical asset that bears no interest, it faces stiffer competition when interest rates go up, as alternative yield-bearing assets become much more attractive to investors seeking a return.
Furthermore, an aggressive interest rate policy by the US Federal Reserve typically strengthens the US dollar index. A stronger dollar is generally viewed as a negative factor for the gold price. However, this downward pressure may be offset by high inflation. Unless the Federal Reserve implements much larger rate increases than currently expected, inflation is likely to outpace interest rates. This leaves the public in a negative real rate position, which historically tends to be highly positive for gold prices.
Why did the Bank of England raise interest rates despite concerns over the Omicron variant?
The Bank of England decided to raise interest rates to 0.25 per cent in mid-December due to strong economic indicators that outweighed immediate concerns regarding the fast-spreading Omicron coronavirus variant. A primary driver was the latest domestic inflation data, which revealed a substantial 5.1 per cent annualised rise in prices for November, representing the highest inflation level the UK had experienced in over a decade.
Additionally, the decision was supported by very strong employment data showing that UK employers had hired a record number of staff. This robust jobs market, combined with the urgent need to address surging inflationary pressures, convinced the central bank’s rate-setting committee to act. The move surprised some market commentators who expected policy makers to wait and assess the economic impact of the Omicron variant first.
