Calamity Kwasi

JOKES

It has been very, very hard to resist but we will not be making any jokes about Kwasi Kwarteng today. The sheer speed of events risks the joke becoming stale by the time you read this..

SOME OF THE MINI-BUDGET MEASURES ARE DROPPED

Global markets have had another volatile week. In the UK, the focus has been on

the fast-changing economic policy environment with many reports suggesting that

this is helping fuel the recent gyrations in UK asset prices including government

bonds and sterling.

Anticipation of today’s announcement of a further partial reversal of the measures

announced in the mini-Budget prompted a sharp rally in both gilts and the pound.

Ten-year gilt yields touched below 4% and sterling above 1.13 against the US

dollar. However, markets have reacted negatively to the PM’s statement with 10-

year gilt yields rising sharply in a short space of time to above 4.25%, while sterling

has fallen back below 1.12 against the dollar. Bets on the size of the Bank of

England’s rate hike on 3rd November have been cut back from levels seen earlier

in the week. However, markets are still priced for a Bank Rate rise of around 100

basis points and continue to see rates climbing above 5% in 2023.

Speculation had been rife for a few days that further policy reversals were in the

pipeline. The policy change seems to have been prompted by contentions that the

government’s energy subsidy plan and tax cuts meant that UK budget deficit and

debt levels were set to be substantially higher over the medium term. The decision

to cancel the removal of the highest rate of income tax is estimated to make only a

small difference to those numbers and, with Prime Minister Truss seemingly ruling

out cuts in public sector spending, the government was left with only a narrow range

of choices to put the budget on what many regard as a more sustainable path.

Consequently, it was decided to reinstate the previously planned rise in corporation tax but to keep the other tax cuts announced – including the reduction in national insurance. It also seems that the fiscal update on the 31st October is still planned to go ahead but with a new Chancellor of the Exchequer as Kwasi Kwarteng has been sacked. Instead, Jeremy Hunt is now set to make that statement as he becomes the fourth Chancellor in a matter of months.

Meanwhile, the BoE’s emergency purchases of gilts is scheduled to end after today. The measures were extended this week including a move to also purchase index-linked bonds, but BoE Governor Bailey has insisted they will now end despite media reports of a possible extension. However, given the rise in gilt yields this afternoon the possibility remains that the BoE may be forced back into the market next week. There is also speculation that the BoE may have to delay its plans to start active sales of its gilt holdings for a second time.

US INFLATION DATA MAKE CASE FOR FURTHER RATE RISES

Outside the UK, the market focus continues to be primarily on how far interest rates are likely to rise in the face of ongoing inflationary pressures. September data for US CPI showed a smaller than expected fall in headline inflation and a further rise in core inflation including indications that inflationary pressures are continuing to broaden out. The data prompted an initial sell-off in US Treasury bonds with longer-dated yields rising to new highs for the year. However, both bond and equity markets later rallied and seemed to be ending the week on a more positive note. Meanwhile, the data reinforced market expectations that a fourth consecutive 75bp interest rate hike is likely at the US Federal Reserve’s 2 November policy update. Markets have also raised their expectation for next year’s peak in US interest rates to close to 5%, although they also still see a risk that Fed tightening will go too far and so will have to be partially reversed late next year.

The coming week’s international calendar is relatively light. Possibly the most interesting data will be the Q3 GDP and September industrial production and retail sales reports for China (all Tue), given concerns that growth there is continuing to disappoint. Meanwhile, comments from Fed and European Central Bank officials will be watched for further clues on the size of likely interest rate increases at their upcoming policy meetings.

UK INFLATION EXPECTED TO HIT NEW 2022 HIGH

The coming week’s UK data calendar may be overshadowed by other developments. Nevertheless, there are some important releases that will potentially impact on the BoE’s November policy update. Wednesday’s inflation release is likely to prompt most interest. We expect that to show a rise in annual headline CPI inflation to 10.2% in September, a new high for 2022. It is forecast to rise further in October partly because of higher energy prices, albeit the rise is now expected to well below earlier projections due to the government’s energy subsidy. Core inflation (excluding food & energy) is also expected to rise to 6.6% from 6.3% and may show a further broadening out in inflationary pressures. The BoE is likely to be particularly interested in whether service price inflation has picked up, a potential indication of the impact of labour market pressures.

The GfK consumer confidence measure showed confidence down to an all-time low in September despite the announcement of the energy subsidy. Given the news over the past few weeks, particularly the concerns expressed about rising mortgage rates, it would be no surprise if it has fallen again in October (Friday). Despite the ongoing weakness in sentiment, we think it is probable that retail sales may have risen modestly in September (Friday) after a big fall in August. Nevertheless, the underlying trend for sales remains weak, given various headwinds. An additional uncertainty for the September data is the potential impact of the bank holiday associate with the Queen’s funeral. However, it seems most likely that any consequent loss in sales were made up for on other days.

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