BoE, ECB's hawkish tone may not halt Sensex, Nifty bull run just yet, but heed to red flags

It is advisable to take heed of the signals from the Bank of England and ECB, suggesting a possibility of a prolonged period of higher inflation

The sleigh of Santa Claus kept pacing up in the Indian markets on December 15 as investors remained in the risk-on mode as the US Fed chair's dovish remarks echoed louder than the hawkish voices of the Bank of England and the European Central Bank.

The bulls of Dalal Street looked unfettered, as the BSE Sensex breached the 71,000-mark for the first time and the NSE Nifty 50 surpassed 21,300 points during the day, despite both the ECB and BoE saying that they were in no hurry to join the US pivot towards interest rate cuts.

While Fed chair Jerome Powell hinted at turning the focus on reducing the borrowing costs, peers from Frankfurt to London declared that the cooling off in inflation can’t be taken for granted. The European officials signalled that easing isn’t on the agenda for now, and restrictive monetary policy would remain in place until needed.

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Not much impact on Indian equities

The US Fed's dovish stance triggered a rally in global markets with Dow Jones, S&P 500 and Nasdaq indices hitting their fresh 52-week highs and record closing highs. The optimism trickled to Asian markets as well with the benchmark indices in Japan, South Korea and Hong Kong logging in gains. The Indian benchmarks too scaled their fresh all-time highs.

According to Shantanu Bhargava, managing director and head of discretionary investment services at Waterfield Advisors, the Fed policy continues to be the beacon for global markets, and European posturing on rates matters relatively less.

"When God (the US Fed) has shared a dovish outlook, other central banks will follow suit as well," said AK Prabhakar, head of research at IDBI Capital, adding that India is more dependent on the dollar economy, and there would not be much of an impact on the market from the European hawkish outlook.

Heed to ECB, BoE warnings

The Fed commentary suggests an interest rate peak, leaving room for adjustments. Fed officials hinted at three potential rate cuts next year unless there are significant changes. The market, especially the bond market, is even more dovish, anticipating more rate cuts than what the Fed is indicating based on expectations of a continued cooling in inflation.

Also read | ECB and BOE are reluctant to join Fed in pivoting toward rate cuts

However, the enduring concern lies in the threat of inflation resurging, according to Unmesh Sharma, head of institutional equities at HDFC Securities.

Back in the 1970s, then Fed chair Arthur Burns eased the monetary policy too quickly, leading to a resurgence of inflation. This shows the inherent risk that inflation can undergo substantial revivals. One should remain open to the possibility of this taking place, said Sharma.

In case of such a scenario, the European central banks would be correct, leading to delayed and less extensive rate cuts than anticipated. "This might trigger a return to a risk-off sentiment in the market," he added.

If there is a shift to risk-off mode, emerging markets, including India, which are considered risk assets, may get negatively impacted. As India holds a significant position as the second-highest weight in the emerging market basket, there might be potential outflows from foreign portfolio investors (FPI), Unmesh Sharma told Moneycontrol.

"Looking at it from a historical perspective, it is advisable to take heed of the signals from the Bank of England and ECB, suggesting a possibility of a prolonged period of higher inflation," he said.

Also Read | Sensex tops 71,000, Nifty hits another high; hawkish BoE, ECB fail to break record run

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