The FTSE 100 (^FTSE) gained almost 1% on Wednesday as stronger than expected UK GDP numbers and a rotation into cyclical stocks boosted the index.
London's bluechip index rose 0.8% to close just above the 7,000 mark. It followed a sharp decline on Tuesday and the index remained more than 1% below where it started the week.
Even still, the FTSE was a standout performer globally. Higher than expected US inflation numbers sparked a second day of heavy selling on Wall Street, while European indexes were subdued.
Inflation continued to dominate investor attention. Data published early morning East Coast time showed US inflation hit 4.2% in April. It was the highest reading since September 2008, according to the US Bureau for Labour Statistics.
Economists had expected inflation to hit 3.6%. Even that had worried markets — stocks tanked around the world on Tuesday as investors fretted about the implications of soaring inflation.
US futures dropped when the data was published on Wednesday and Wall Street faced heavy selling when markets official opened.
By the time Europe shut, the Nasdaq (^IXIC) was down 1.9%. Higher rates are particularly daunting for growth-focused tech companies that rely on cheap capital to fuel their expansion. The Dow (^DJI) was down 0.8%and the S&P 500 (^GSPC) lost 1.1%.
The inflation print sent shockwaves globally. The DAX (^GDAXI), CAC 40 (^FCHI), and FTSE 100 all dipped briefly before recovering. Neil Wilson, chief market analyst at Markets.com, described the price action as a "wobble".
Investors are concerned that huge amounts of stimulus spending in the US will cause the economy to overheat. Rapidly rising prices could force central banks to raise interest rates and prematurely curb the recovery from COVID-19.
Read more: Why are investors worried about inflation?
April's inflation reading was partly driven by largely mechanical increases in fuel prices. Oil prices collapsed this time last year but have since normalised, leading to what looks like large percentage increases when prices are compared.
However, elsewhere the data pointed to signs of more fundamental changes. Used car prices jumped 10%, which was likely a result of fresh rounds of stimulus cheques issued last month. It was the biggest one month increase since records began in 1953.
"Markets were already expecting a rise in inflation – the big question is how sticky that inflation is," said Seema Shah, chief strategist at Principal Global Investors. "That has not been answered today, nor will it be answered for several months."
The US Federal Reserve is willing to tolerate interest rates rising above 2% for a time as it believes the factors driving the current surge are only temporary. That is not a view shared by the market. Many investors believe the ongoing stimulus spending will combine with an already rebounding economy to create runaway price rises.
"Going forward, the big question is just how long can the Fed can maintain its dovish stance in opposition to the markets, particularly if companies begin raising wages to encourage unemployed labour back into the workforce, in turn driving a large hole in the Fed’s transitory inflation argument," said Stuart Cole, head macro economist at Equiti Capital.
Earlier in the day, the FTSE 100 had rallied on better than expected GDP data. Official data published on Wednesday showed the UK economy contracted by 1.5% in the first quarter of 2021, which was slightly ahead of City forecasts. Growth also rebounded by 2.1% in March, which was a much stronger bounce back than expected.
"Today’s monthly GDP estimate reveals the fastest monthly growth since August 2020 and is further evidence that the economy is moving in the right direction at a significant pace," said Ian Warwick, a managing partner at Deepbridge Capital.
The FTSE 100's heavy reliance on banks and financial companies — which, unlike tech, benefit from higher interest rates — helped cement the strong performance as investors looked for inflation-safe bets to park their money in.
"Higher inflation is net good for the UK market since it’s weighted to cyclicals not tech," Wilson said. "Strong inflation readings ought to support the UK blue chip index."
Official data published earlier on Wednesday showed German inflation running at 2% and French inflation at 1.6%.
Watch: What is inflation and why is it important?
The mild GDP slump and quick recovery came despite a return to lockdown at the start of January. Restrictions remained in place for the entire first quarter.
Ulas Akincilar, head of trading at INFINOX, said: “In the end the first quarter turned out to be a factory reset rather than a collapse for the UK economy. A 1.5% slowdown across the three months as a whole isn’t just better than forecast, it also feels like a Houdini-esque escape."
Smirnoff-owner Diageo (DGE.L) shot to the top of the FTSE 100, rising 3.7% after restarting plans to return billions to shareholders.
Overnight in Asia, Japan's Nikkei (^N225) and the South Korean KOSPI (^KS11) both dropped around 1.5%. Australia's ASX 200 (^AXJO) slid 0.7%. Elsewhere in the region, prices found a floor. The Hong Kong Hang Seng (^HSI) rose a third of a percent and the Shanghai Composite (000001.SS) gained 0.6%.