What happened last week does not happen often in financial markets or economies. The Bank of England hiked interest rates by 50 basis points and suggested they may have to step up monetary tightening in the face of a weaker pound and looser fiscal policy. That was also despite an admission that the UK economy was already in recession, and the fact that the economic outlook appears to have worsened significantly in spite of large parts of the package of fiscal measures unveiled by Chancellor Kwasi Kwarteng. 

That package of measures included the assistance with household energy bills, costing tens of billions for the first six months alone, a reversal of the National Insurance hike for employers and employees, a basic rate income tax cut, a scrapping of the top rate of income tax (currently 45p in the pound on incomes over £150,000) and a cut in stamp duty on housing. The measures went a lot further than had been expected, but I fear aren’t enough to plug the growing black hole in household incomes.   

The pound dropped firstly below previous lows at $1.1351, then beneath the key technical level at $1.1343, and the losses accelerated into the end of the week, with $1.10 breaking and GBPUSD reaching a low at $1.0840. To be clear, this came as the markets were pricing in even more aggressive monetary tightening from the Bank of England, with the terminal rate predicted to be above 5.5% after Friday’s drama.  

This week has already seen the pressure on the GBP intensify. Fears over an intra-meeting rate hike from the Bank of England have increased, with the markets pricing in an additional 33 basis points of tightening as of Monday. The pound fell to a low of $1.0350 in Asian trading, while GBPEUR fell to €1.0787 - its lowest level since 11 September 2020. If the Bank of England was to choose to move interest rates to anything like the levels being suggested by market forecasts, the effect on the UK housing market could be catastrophic, with mortgage interest payments on an average mortgage increasing by many hundreds of pounds per month and deducting far more from household incomes than the support offered from the government, in my view. 

The Bank of England have has tried raising rates to defend a the currency and solve an inflation problem once before, and not only did it not work, it caused a further run on the pound, back in 1992. There may be some medium to long-term support for the GBP, in that assets in the UK will look cheap in foreign currency terms. However, the pound has to find a base first and I suspect that means lower against the US dollar and euro over the coming weeks and months.

Last week saw comments from the ECB (European Central Bank) Governing Council members including Rehn, Nagel, Chief Economist Lane, President Lagarde and Schnabel. There was general agreement that the ECB will have to go further in the fight against inflation, and despite the weakening in some economic data and surveys, exposure of Euroland to Russia’s gas pipeline closure, and rising financial stability risks, there was no indication of concern about the economic outlook. That didn’t stop the euro from sliding further against the US dollar, and it reached a low of $0.9668 - its lowest level since September 2002.

In terms of the weaker economic evidence, last week saw record lows for Dutch, Belgian and Euroland September consumer confidence readings, and poor provisional September manufacturing and services PMI (Purchasing Managers’ Index) outturns. However French business confidence held up, and there was a surge in producer price inflation from Germany in the August data, though signs of a slowing in the pace of PPI (Producer Price Index) inflation in the likes of Portugal, Slovenia, Latvia and Ireland. Already this week we have had the German IFO* business climate survey for September. This reported a larger-than-expected drop in the business climate index, with expectations taking a larger dip than current conditions, but both falling to the lowest levels since the height of the pandemic.

The release of more confidence data for September and October this week is accompanied by Euroland M3 money supply data, and September consumer price inflation figures from Spain, Germany, France, Italy and Euroland. The figures should show a weakening in confidence, in line with what has been seen last week, a slowing in the pace of money supply growth but a further jump in Euroland consumer price inflation figures. There may also be interest in unemployment figures for September from Germany and August from Euroland.

There will be nothing from this week’s releases to aid the euro in its recovery, but given the sizeable drop against the US dollar over such a short space of time, the euro may benefit from some profit taking on the part of recent euro sellers.

* Information and Forschung (Germany’s Institute for Economic Research) 

Jerome Powell and the rest of the US Federal Reserve remain in no mood to slow the pace of interest rate tightening, in spite of the growing signals from the US economy of the increasingly poor health of the housing market and the retail sector. There was some respite from the housing market data in the latter stages of last week with housing starts up in August, latest weekly mortgage applications rising 3.8% and existing home sales holding up unexpectedly in August, but this is likely to be noisy weekly and monthly data, rather than the end of the downturn. The US manufacturing and services PMIs (Purchasing Managers’ Index) also improved unexpectedly, with the latter almost recovering back to the 50 level that would have signalled a stagnation in the sector. 

The Federal Reserve’s statement accompanying its decision to hike interest rates to 3.25% indicated that they would stay the course of monetary tightening for as long as necessary, but the latest leading index release recorded a sixth straight drop. When was the last time the leading index fell for six months in a row? That would be the financial crisis of 2008. The Fed should be careful what it wishes for, in that in the fight against inflation the economic sacrifice may become too painful.

For this week, the Federal Reserve has more housing market, consumer confidence and business confidence figures to analyse. The risks are that the figures are modestly positive, which could be viewed by the monetary authority as more reason for it to continue the course of tightening policy. The US dollar, which reached fresh highs last week, has risen sharply in recent sessions, and I think could give back some of its gains this week. The slump in risk appetite might be harder to turn around, especially with central banks including the Federal Reserve pushing the case for further aggressive tightening, in my opinion.

The last week was one full of central bank announcements where, on the face of it, nothing much changed. The Swedish Riksbank hiked interest rates to 1.75%, more than the markets had expected, with the authorities worried that higher rates of inflation expectations would become entrenched. However, the Swedish economy has already shown signs of a weakening, and it is likely, in my view, that economic conditions are set to materially worsen swiftly. 

The Brazilian central bank left interest rates at 13.75%, in line with consensus expectations. The Philippines borrowing rate was hiked to 4.25%, the Bank of Indonesia hiked interest rates also to 4.25% (more than the 4% expected), and the Norges Bank (Norway), Swiss National Bank and South African Reserve Bank all hiked official interest rates to levels of 2.25%, 0.5%, and 6.25% respectively in line with expectations. There was a surprise from the Turkish central bank, which cut interest rates to 12%, and despite the lira having remained under pressure. Finally, National Bank of Poland Monetary Policy Council member Kotecki suggested that the central bank would pause in its interest rate hiking cycle. 

This week sees meetings of the central banks of Hungary, Thailand, the Czech Republic, Mexico, India and Columbia. All central banks are expected to hike interest rates, with the exception of the Czech Republic, which should stand pat. Hungary is forecast to lift interest rates a further 75 basis points, Thailand by 25 basis points, Mexico (Banxico) by 75 basis points, India by 50 basis points, and Columbia by 150 basis points. Many of the central banks are fearful of moving out of step with a hawkish Federal Reserve, whilst others remain concerned by inflation despite signs of growing disinflationary forces. Given the pace of tightening in monetary policy, I see a growing risk of a global economic slump, rather than a recession.