Calm Before The Storm

CALMER WEEK

Sterling markets stabilised over the past week, but the outlook remains uncertain. The pound had fallen to a record low of $1.04, partly reflecting broader US dollar strength, but it has subsequently recovered above 1.10 to levels before the Chancellor delivered his Growth Plan. It has also pared losses against the euro. The BoE delayed its planned start of active gilt sales (quantitative tightening) and its intervention to temporarily buy long-dated paper for address market ‘dysfunction’ has helped to lower gilt yields. The 30-year gilt yield, for instance, fell below 4% having soared above 5%. However, whether this fall in yields will be sustained once temporary purchases end on 14 October remains to be seen. BoE Chief Economist Huw Pill indicated that the government’s fiscal plan would lead to a “significant monetary policy response”, although he played down the likelihood of an interest rate hike before the next scheduled update on 3 November. Markets have reined back their expectations for Bank Rate but, at the time of writing, are still pricing in at least 125bp of increases (to 3.5%) by early November and see it above 5.5% next spring.

SPOTLIGHT ON UK PM AND CHANCELLOR

The government’s fiscal plan aimed at boosting long-term growth was lauded by business organisations, but most analysts believe markets were concerned about the lack of an independent economic assessment from the Office for Budget Responsibility (OBR). The Treasury has subsequently announced the Chancellor will deliver a Medium-Term Fiscal Plan which will be accompanied by new OBR forecasts on 23 November. There are reports of political pressure for this date to be brought forward to provide clarity to the efficacy of the fiscal measures which the PM and Chancellor have doubled down on. The OBR has said it will provide a first ‘iteration’ of its forecasts to the Chancellor next Friday and will also set out a full timetable next week for the period to 23 November. The focus will remain on domestic politics as the Conservative Party conference in Birmingham gets under way. PM Liz Truss is scheduled to deliver a closing speech on Wednesday as she faces pressure to help shore up investor confidence and with latest polls pointing to a widening lead for Labour. Economic releases are few and far between but include the final readings of the September manufacturing and services PMI survey, the construction PMI and the BoE’s latest Decision Maker Panel (DMP) survey of businesses. Last month’s DMP data showed a further increase in 3-year ahead inflation expectations, which are closely monitored by the BoE, to 4.2% from 4.1%.

ECB ‘ACCOUNT’ IN FOCUS AS INFLATION SOARS

In the Eurozone, headline CPI inflation has continued to soar, with the flash estimate for September reaching 10.0%, up from 9.1% in August and above consensus forecasts for an increase to 9.7%. Particularly concerning for the ECB will be further rises in core inflation (excluding food and energy) to 4.8% reflecting increases in both core goods and services inflation. Despite further signs of economic slowdown from the German IFO survey and the Eurozone economic sentiment index, with energy insecurity a major downside risk, there is not likely to be any let-up in monetary policy tightening by the ECB in the coming months. The ‘account’ of the ECB’s September meeting will be published on Thursday. That was the meeting when interest rates were raised by a record 75bp to 0.75% for the deposit rate. As future policy decisions will be data-dependent and taken on a ‘meeting by meeting’ basis, it is not clear how much additional signals in their likely path there will be in the minutes as markets gauge how quickly and much further Eurozone rates will rise. President Lagarde has nevertheless indicated that more hikes are to be expected in the remaining two policy meetings this year and possibly in early 2023 and that the ECB is frontloading hikes. Hence, another 75bp hike in October cannot be ruled out. The Reserve Bank of Australia and the Reserve Bank of New Zealand will be the latest central banks in the coming week to increase rates. Both are predicted to raise rates to 2.85% and 3.5%, respectively.

US LABOUR DATA TO SUPPORT MORE FED HIKES

Across the Atlantic, the US will be assessing the damage mainly in Florida from Hurricane Ian. It seems unlikely, however, to affect Fed monetary policy which remains focused on getting inflation back down. The coming week’s US data are not expected to alter the Fed’s plans for significantly further tightening. The ISM manufacturing and services reports for September are expected to remain above the 50 growth/contraction threshold. The spotlight, however, will primarily be on the official September labour market data on Friday. Some analysts described last month’s labour report as ‘goldilocks’, where nonfarm payrolls growth slowed but remained robust at 315k, wage growth showed tentative signs of cooling and the unemployment rate unexpectedly rose to 3.7% from 3.5% driven by higher labour participation. The Fed will nevertheless remain attuned to the tightness of the labour market. For September, indicators point to another good month for jobs growth – we have pencilled in a rise of 280k for nonfarm payrolls – while the unemployment rate may tick back down to 3.6%. Average earnings growth will be closely watched too after rising by 0.3%m/m last month, the least since April – we forecast a rise of 0.4%m/m in September.

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