27 October 2022: Sunak preparing for the worst

GBP – Market gearing up for financial report

Successive Prime Ministers and Chancellors have all feared the publication of the Office for Budget Responsibility’s economic forecasts, which were due to be delivered next week.

Instead of the OBR report, Chancellor Jeremy Hunt will deliver a full budget statement on November 17th, accompanied by fresh economic forecasts from the OBR.

Rishi Sunak and Jeremy Hunt will bear the responsibility for repairing the damage caused by Liz Truss in the final days of her Premiership. But Sunak has promised to tackle the daunting prospect of more austerity with the utmost care.

It is hard to see how the Prime Minister can afford to provide the NHS with anything close to the amount of funding it will need but there may be some movement immigration, as Sunak is known to favor more liberal regulations.

Sunak rejected the Opposition calls for an immediate General Election. The rationale for an election is that since no one voted for the current Prime Minister, he does not have a mandate to govern. Such an argument is deliberately obtuse. It lends itself to American electoral rules rather than British.

Sterling faces significant resistance against the Dollar around the 1.1740 level, which could be tough to break before the Prime Minister sets out his response to the OBR report.

The Bank of England is still committed to hiking interest rates next week, but they may accompany the hike with a relatively dovish statement. That is unlikely to drive the pound higher, although the Gilt Market is beginning to react positively to Mr Sunak’s appointment, which should see the pound enjoy a period of relative strength.

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USD – Raging inflation is a global issue

The Fed has become the scapegoat for those looking for a reason to be critical of official policy. Disaffected Democrats see Jerome Powell as the perfect candidate for blame as he was appointed by Donald Trump.

He made a significant error of judgement in calling the rise in inflation transitory last summer. The Central Bank thus delayed raising interest rates which, according to some, led inflation to climb to its current level.

Coming out of the Pandemic, many felt that the damage done to supply chains would eventually self-correct. However, few could have predicted that Putin was planning a full-scale invasion, and the rise in inflation precipitated by the Ukraine war has been far more severe than ever imagined.

Inflation has been made worse by Russian interference in energy prices.

The US is currently engaged in a dispute with Saudi Arabia over oil supply as they appear to have colluded with Russia to engineer supply cuts that keep the price of oil artificially high.

Over the past six months, the Fed has continued to hike rates to slow demand and, by doing so, lower inflation. That plan has barely made a dent in inflation that has continued to rise.

It has become evident that tighter monetary policy – in an economy with interest rates at historic lows – would only work once they moved into restrictive territory.

It is a tough call, but a further hike in interest rates next week is justified, although the FOMC should probably abandon a December hike.

The Dollar Index has run out of steam over the past few days, and should the hike be anything other than seventy-five basis points, the index could suffer considerable damage.

The index retraced further yesterday, falling to a low of 109.63 and closing just five pips from that level.

After a period of unmatched strength for the Dollar, traders are beginning to sense a recession led by a considerable fall in employment.

EUR – Lagarde will have her work cut out to seem impartial

The ECB meets today, with an interest rate hike of seventy-five basis points expected to be agreed. The most up-to-date data that has been published suggests that the Eurozone, led by Germany, is headed for a severe recession.

The most recent advance guidance provided by ECB President Christine Lagarde and her Chief Economist has been ambiguous to ensure that the Central bank’s actions don’t become too predictable.

All they have done is create an atmosphere that has led to a false rally for the single currency, in which they are bound to raise interest rates.

While all G7 nations are seeing a slowdown attributed to the war in Ukraine, the Eurozone finds itself on the frontline, constantly being placed under pressure by Russian interference with the gas supply.

It is possibly doing the market a disservice to say that current volatility is attributable to Central Bank monetary policy. The ECB felt it needed to support the weaker members of the Eurozone, whose position was worsened by the Pandemic. The delay in withdrawing support added to rising inflation as demand outstripped supply in several areas of the economy, and continuing support merely threw fuel on the fire.

The first complaints came from Germany, who felt that their citizens, short-changed by a decade of low interest rates, were now seeing their savings eroded by continually rising inflation.

They have been joined in the calls for higher rates by several wealthier members of the Eurozone, who benefit from far higher savings rates than the rest of the region.

Now the ECB stands on the brink of a historic rise in interest rates which will take place against a backdrop of weakening output which now seems certain to lead to a recession early in the New Year.

The Euro regained parity with the Dollar yesterday, driven by the belief that the ECB will continue to hike just as the US tapers its recent tightening of monetary policy.

The week could supply details of a notable change to how the markets view the relative strength of G7 currencies.

The Euro rose to a high of 1.0088 yesterday and closed at 1.0079. This could be seen as an opportunity to renew short positions, but a lot depends on how hawkish the ECB President is in her press conference later.