A Bonfire of Sterling Assets

STERLING ASSET PRICES UNDER RENEWED PRESSURE

UK government bond yields had fallen after the BoE began temporary gilt

purchases, but yields started to rise again over the past week. The initial

intervention to buy long-dated paper sought to address market ‘dysfunction’ as

soaring yields led to parts of the pensions sector being forced to sell gilts to raise

funds, leading to a ‘self-reinforcing spiral’ of higher yields and further forced selling.

The BoE’s gilt acquisitions, however, have been significantly below the £5bn daily

ceiling and have been scaled back this week. They are due to expire on Friday 14

October. The 30-year gilt yield remained below recent highs but has risen back

above 4%, while the pound came under some renewed selling pressure.

POTENTIAL VOLATILITY DRIVERS

There remains speculation and political pressure for the Chancellor’s

fiscal plan, accompanied by OBR forecasts, to be brought forward from 23

November, to allow a more immediate assessment of how the government will

balance the books. It may also affect the BoE’s impending monetary policy update

on 3 November, with its Chief Economist Huw Pill having indicated that the

government’s fiscal loosening will prompt a “significant and necessary monetary

policy response”. Markets are pricing in more than a 100bp rate rise by early

November. Several BoE MPC members are scheduled to speak in the coming week, including Governor Andrew Bailey (Tue) as well as Pill, Cunliffe, Mann and Haskel. And in addition to the expiry of temporary gilt purchases this coming Friday, the BoE is (re)scheduled to start quantitative tightening (QT) – the reversal of QE – at the end of the month.

UK LABOUR MARKET AND GDP DATA DUE

Several key UK economic data updates will be released ahead of the early November BoE policy announcement. In the coming week, the focus will be on the labour market (Tue) and monthly GDP for August (Wed). The recent monthly labour figures have pointed to some weakening in employment. Nevertheless, the indications are that the labour market remains tight, with unfilled vacancies still high and the unemployment rate falling to a 48-year low of 3.6%, led by more people becoming inactive, due in part to a rise in long-term illness. As a result, upward pressure on nominal wage growth has continued. We forecast a fall in employment of 200k on a 3m/3m basis (June-August vs March-May) and for the unemployment rate to hold at 3.6%, while both headline and regular wage growth are predicted to tick higher to 5.9%y/y and 5.3%y/y, respectively, but remaining below inflation.

For August GDP, we anticipate a marginal fall of 0.1%m/m after the 0.2%m/m rise in July. Services activity probably contracted by 0.1%m/m, reflecting the impact of recent strikes and the fall in retail activity, while seasonal maintenance in the oil and gas sector may have dragged overall industrial activity lower despite a forecast rise in manufacturing output. It is also worth noting that the additional bank holiday for Queen’s state funeral is expected to weigh on September activity. There is a risk of a fall in Q3 GDP, and the BoE’s latest forecast is for a decline of 0.1%q/q. Looking further ahead, the energy price cap will lower the peak in inflation and provide support to economic growth, but further interest rate rises will slow activity.

SCRUTINY ON US CPI AND FOMC MINUTES

Over in the US, the focus is the FOMC minutes (Wed) and the CPI inflation data (Thu). Retail sales and the University of Michigan consumer sentiment survey (both Fri) will also be released. Some recent soft economic data – including the ISM manufacturing survey, construction spending and job openings – have not swayed the Fed’s focus on getting inflation down. Other data showed the US economy added a further 263k jobs in September while the unemployment rate fell back to 3.5% from 3.7%. Policymakers have remained hawkish and the FOMC minutes will principally be watched for clues on how much further interest rates are likely to rise (the dot plot suggests another 150bp in total), including what to expect for the update on 2 November. Markets have almost priced in another 75bp increase for the next meeting.

Headline CPI inflation has fallen back in the past two months, led by lower energy prices, but it remained high at 8.3% in August. The picture for core CPI (excluding food and energy) appears to be less comforting, suggesting that high wage growth is leading to a broader pickup in inflation. We expect September headline CPI to fall again to 8.0%, but core inflation to move up to a forty-year high of 6.6%. The recent improvement in consumer confidence, helped by lower gasoline prices, will likely support core retail sales.

The Eurozone focus will be on ECB speakers, including President Christine Lagarde (Mon/Wed) and Chief Economist Philip Lane (Mon/Tue) at different events. With Eurozone CPI inflation at 10.0% in September, the ECB is set to continue raising interest rates in the upcoming meetings, including the possibility of another 75bp hike on 27 October, despite business survey evidence pointing to a loss of economic momentum and the possibility of contraction in Q3.

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None of the information in this article is, nor should be construed as financial advice. All foreign exchange transactions involve risk and you should always seek your own independent financial advice before entering into any foreign exchange transaction.