12 October 2022: Truss bows to pressure over benefits

GBP – She approves increase equivalent to inflation

Bank of England Governor Andrew Bailey spoke yesterday of the turmoil that the Government’s new policies have brought to the gilts market and confirmed that additional support provided by the Central Bank must end this Friday.

The fear that pension funds will begin a fire sale of UK government assets, driving long term interest rates higher, could complete the total breakdown of the market’s confidence in the Treasury.

The Governor went on to say that any intervention in markets is simply to stabilize the situation, and market users cannot become reliant on official support. Therefore, any action taken by the Bank of England will be temporary and must end on Friday.

There is a clear fracture between the fiscal actions of the Treasury and the monetary actions of the Bank of England. The Office for Budget Responsibility in a preliminary report that will be fleshed out on 31st October spoke of its expectation that it will take around sixty billion pounds worth of reduction in Government spending to balance the books.

The Prime Minister appears to have again been forced into a U-turn by Conservative backbenchers. In April, then Prime Minister Boris Johnson pledged to increase certain benefits in line with inflation. Truss was asked about this when she took up the role, and she refused to commit to Johnson’s promise.

During the Party Conference last week, she appeared to be leaning towards the lower increase in line with average wages. However, she appears to have been persuaded that the additional five billion pounds of spending will be worth it.

The Pound had a rough day yesterday and the outlook is for more of the same. It fell to a low of 1.0953 and closed at 1.0968. The surprise factor for Kwarteng’s recent mini budget is no longer a factor so Sterling is likely to drift lower without any major fall.

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USD – Economists believe that a storm in brewing in the economy

President Biden had soothing words for the American people when spoke yesterday of his expectation that the economy would go through a rough patch, but any recession would be mild and barely noticeable to most people.

The end of the Pandemic is well past now, and supply chains have mostly returned to normal.

He expressed his confidence in Fed Chairman Jerome Powell and his team at the Central Bank who are putting measures in place to battle inflation, and signs are that the tide is beginning to turn.

He went on to say that the Fed should have inflation sufficiently under control to be able to turn its attention to supporting the economy should that be needed.

Furthermore, he sees the period in which interest rates stay high compared to recent times to be relatively short.

His words failed to encourage markets who are still digesting the comments from several banks including Bank of America. They foresaw a fall in employment throughout the first quarter of 2023 and appear to be supported by the International Monetary Fund. The IMF reduced the estimate for global growth in 2023 from 2.5% to 2.3% and warned that the darkest time was still ahead.

Later today, the minutes of the latest FOMC meeting will be published. They hold little value to the market, as the attitudes of the majority of Fed Presidents who make up the committee are well known. There may be some discussion about how high rates are likely to rise now that they are restricting the economy, but since the Central Bank professes to be data led, more notice is expected to be taken of the latest inflation figures.

The Dollar Index is still in a narrow range while traders consider the magnitude of the next hike.

It traded between 112.40 and 113.50 yesterday, closing at 113.28

EUR – Quixotic ECB President still fighting imaginary enemies

The President of the European Central Bank, Christine Lagarde, jumped from the relatively peaceful (at the time) frying pan into the raging fire when she took on her latest role.

She could be forgiven for believing that Mario Draghi had handed her a poisoned chalice when he left Frankfurt for Rome.

She landed in Frankfurt and was at once faced with an economy that was facing the Pandemic and only had fiscal support with which to fight a fast-approaching enemy.

The voracious appetite of the Eurozone for direct funding, as well as a guarantee for their direct liabilities, was barely sated when Lagarde realized that all that support was fuelling inflation.

This combined with the invasion of Ukraine by Russia and Russia’s ‘difficulties’ in fulfilling its obligations to supply energy, primarily gas, has seen wider prices rise by an average of close to 11% over the past few months.

The IMF sees the situation as worsening considerably and while the rise in inflation is a constant and obvious issue, they predict GDP at just 0.5% in 2023 and only marginally higher in the following year.

This points to stagflation, a situation that is like quicksand, once entered it is exceedingly difficult to exit.

The much-vaunted tools that were going to be created to allow the most indebted nations to borrow at rates not too far from Germany, appear to have been jettisoned. The ECB would be well served to be considering ways to extricate Eurozone members who find themselves mired in stagflation.

The Euro attempted to test resistance at 0.9780 yesterday and fell just short, making a high of 0.9774. It slipped back to close at 0.9709.