Last week saw Rishi Sunak take over as UK Prime Minister after Liz Truss’ resignation. He immediately altered the front bench team, although some members of the former cabinet remained, including Chancellor Jeremy Hunt, Foreign Secretary James Cleverly, and Defence Secretary Ben Wallace. The news continued to settle the markets, albeit that yields rose marginally towards the end of the week. The UK fiscal statement will be delayed to 17 November from 31 October, with the new team looking to do a thorough review of the measures outlined in the previous mini-Budget that created the upheaval in markets only a few weeks ago.

Expectations for the tightening in UK interest rates due on Thursday of this week have continued to drift off, with the markets now pricing in less than 75 basis points at the November meeting, which is accompanied by the quarterly monetary policy report. Could the Bank of England only hike by 50 basis points? Possibly, but I see that as unlikely given the inflation overshoot and previous statements from numerous Monetary Policy Committee members. The vote though could be split, with potentially two to three members of the Monetary Policy Committee voting for only 50 basis points.

There is a lack of other notable releases due this week from the UK. There should be further signs of a slowdown in economic activity and a further reduction in the pace of house price appreciation. Both of these are thanks to the jump in inflation, the partial effects of the tightening in monetary policy already in the system, and a worsening in global economic conditions.

The risks to sterling are to the downside, in my view, after the rally enjoyed in recent weeks. The markets are grappling with a worsening domestic economy and high inflation. The choice that the Bank of England has to make will possibly look problematic whichever decision it takes, and as we saw with the ECB (European Central Bank) meeting last week, the currency is likely to be vulnerable regardless, in my view. We’ve seen a few weeks of consolidation, but how much upside does the pound have left?

Last week’s crucial event was the ECB (European Central Bank) Governing Council meeting. As expected the ECB raised all rates by 75 basis points, but it also made some other adjustments that weren’t as expected or hawkish. In particular the accompanying statement was substantially altered, such that it no longer indicated hikes over the coming meetings but instead suggested only that the ECB ‘expects to raise rates further’. Commercial banks also saw the ECB’s generosity from the TLTROs (Targeted Longer-Term Refinancing Operations) disappear, with the ECB ending the riskless carry on TLTRO-iii from late November, which in turn is expected to prompt at least a €1 trillion repayment of reserves. However, the ECB recognises that there is a collateral squeeze that such measures will only marginally alleviate, and the economic outlook was seen continuing to deteriorate.

The ECB is likely to increase interest rates a further 75 basis points from here, which would leave the deposit rate at 2.25% and the refinancing rate at 3%, which would still mean both are at the highest levels since 2008, at the midst of the financial crisis. The euro fell back after the ECB’s decision, as market interest rate expectations reduced and also likely on the back of the worsening economic conditions. The downside threats to the euro remain against the US dollar, although the markets will be closely watching the release of German factory orders figures for September towards the end of the week.

After the surge in Italian consumer prices data last week, the already Italian Q3 GDP (Gross Domestic Product) figures provided a lift for the markets, with Q3 GDP growth coming in at 0.5% quarter-on-quarter, a stunning result for the 3rd largest Euroland economy. Overall Euroland GDP grew by 0.2% quarter-on-quarter, whilst October consumer prices surged to 10.7% in October, although appear to be close to a peak. The ECB may be reluctant to hike by another 75 basis points, but the CPI (Consumer Price Index) surge will likely prompt a 50 basis point hike in December, in my view.
 

The Federal Reserve sees no need to slacken the pace of rate increases at the upcoming FOMC (Federal Open Market Committee) meeting this Wednesday, but has there been sufficient data from the US economy to suggest that the damage being done to growth is building?

If we look at last week, there were warning signals from the housing market, from the provisional PMI (Purchasing Managers’ Index) surveys and also from consumer confidence numbers released by the Conference Board. There have also been comments from some sections of the Federal Reserve that suggest voting members are becoming more nervous about the surge in borrowing costs and the damage it will do to the US economic outlook. Even the provisional Q3 GDP figures from the US deserved more scrutiny, since the solid Q3 growth outturn hid anaemic growth in personal consumption.

So the Federal Reserve is expected to hike interest rates by 75 basis points this Wednesday, but what then? Will the statement accompanying the move offer some crumbs of comfort to consumers and businesses facing the highest borrowing costs in over 14 years? Furthermore, if the Fed was to dial down the rhetoric of rate hikes, would that prove a negative for the USD? On this last point I think not, given the weakness observed in other major economies and the downside risks that I still think are evident to risk appetite.

At the end of this week, the US non-farm payrolls data for October is released. The net gains in employment are set to continue, albeit at a slower pace according to consensus expectations, but will there be other signals that demand is reducing? Articles in the UK press over the course of the past week suggest that the risks of significant job losses in Silicon Valley are growing, given the poor earnings performance seen by tech firms in the latest earnings round. There is a steady stream of negative news flowing from the US, so my question is how much longer can the economy hold up?

Last week saw a number of interesting meetings from central banks. First up was the Bank of Israel, which raised interest rates to 2.75% from 2%, in line with market consensus. The Reserve Bank of Australia was next up on the calendar, and it surprised markets by hiking less than was priced for, just 25 basis points when the markets expected double that. The National Bank of Poland also did less than expected, holding rates unchanged when a small quarter point hike had been widely expected, but not before the Reserve Bank of New Zealand delivered a 50 basis point hike. With all central banks the concerns on inflation remained, but with a growing proportion, the concerns over the activity on housing was equally as prevalent. The weakness of a number of currencies has continued in spite of the interest rate increases, suggesting that there is no easy way out of the current situation regarding high inflation, weak growth and weak exchange rates versus the US dollar.

This week sees only the central banks of Chile, South Korea and Singapore due to announce. A 75 basis point hike in interest rates is expected from Chile, whilst the Bank of Korea is expected to hike by 25 basis points. As for the Monetary Authority of Singapore, with inflation still elevated, the prospects are for another tightening, but by influencing the exchange rate, rather than an interest rate hike. All central banks will be wary of doing too much, or too little, with a Federal Reserve decision around three weeks away.