2 September 2022: Inflation sees mortgage rates rise

GBP – Average mortgage £200 pcm higher as rates rise

A combination of stronger yields in the U.S. risk aversion and the prospect that inflation could reach 23% early next year saw Sterling fall to a fresh two-year low.

Boris Johnson goes into his final weekend as Prime Minister convinced that there are sufficient reasons to believe that the country can survive and thrive, despite the pressures that are building within the economy.

It has been a feature of Johnson’s Premiership that he has been infected by an almost blind optimism, when forward-thinking and planning would have served him far better.

If the voting members of the Conservative Party want forward-thinking, they will, or at least should, cast their vote for Rishi Sunak. The former Chancellor is pragmatic about the current situation and is honest enough to say that the country faces serious concerns in the short term.

He accepts that there is no quick fix nor is there, to quote Johnson’s predecessor, Theresa May, a magic money tree.

While Sunak acknowledges the tough road ahead, Liz Truss’ policies to deal with the cost-of-living crisis is to grow the economy, however, she has failed to put any meat on the bones and expects to win the election based on the faith of the electorate and personality alone.

It is almost a straight choice between honesty and unproven promises.

The announcement of the result will be made on Monday and coincides with the return of Parliament from its summer recess. There were rumours circulating yesterday that the Treasury has been put on standby about a mini budget being presented within the first two weeks of the new Prime Minister’s tenure.

That is not wholly unreasonable. The question is, who will be trusted to deliver it? If Truss is triumphant, will she acknowledge Sunak’s suitability to return as Chancellor? She has said that there will be a place for him on the Government front bench, while Sunak has made no such commitment.

If Sunak does return to the Treasury, he will ensure that measures are scrutinized to make sure they are able to be fully funded. That will be the time that the substance of Truss’ promises will be truly put to the test.

Sterling fell to a low of 1.1498 yesterday, closing at 1.1544. If truss is triumphant on Monday, it could be that there will be further weakness, although there could be a rally no matter who wins, based upon relief that at last there will be a leader in place prepared to take the tough decisions.

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USD – Central Bank to hike economy into recession?

With ever more strident predictions being made, first about whether there will be a recession in the country in early 2023 and then just how serious a contraction will afflict the economy, the data continues to confound the market.

Data released yesterday showed that the economy is still in expansion. S&P Global published its Global Manufacturing PMI, and although it fell, the fall was by less than the market had expected, and it remained in positive territory.

There was yet more employment data released yesterday, and the two datasets both pointed towards further strength in the employment report that will be published later today.

Challenger job cuts, an extensive report into the areas of the economy that are shedding jobs saw a drop from 25.8k to 20.48k. Were the economy to be in recession already or heading in that direction, it is likely that that number would be heading in the opposite direction.

As mentioned recently, weekly jobless claims appear to have topped out at around 250k. The numbers for the latest period confirm that. The earlier number was revised down from 243k to 237k and in the current week, 232k new claims were registered.

The overriding concern of the market now is how the Fed appears to have become obsessed with trying to use monetary policy to tame inflation, a battle it appears to have little chance of winning.

Cooling demand will only go so far, as globalisation drives supply, and that is where the issue is currently. Yesterday, China announced that a region of more than twenty million people has been locked down due to further outbreaks of Coronavirus. It is not yet known if it is an existing strain or another new variant.

The latest term being coined for the Fed’s policy of hiking interest rates is that they will hike the economy into recession. Yesterday’s data was strong enough to drive a seventy-five-basis point hike this month. Only a major downwards surprise in the headline NFP later today will call that into question.

After this month’s meeting, there will only be two more FOMCs this year, and it may be that there will be a hike at both. However, it is hoped by the doves that they will total no more than one hundred basis points.

The return of lockdown conditions in China saw an upturn in global risk aversion, and this drove the dollar higher. The index reached a high of 110.00 and closed at 109.66.

A lot depends on the strength, or otherwise, of the August employment report, whether the index corrects or makes further inroads above the 110 level.

EUR – ECB facing a tough time to push through another rate hike

There will be a great deal to talk about when the ECB’s Governing Council meets next week. By far the most crucial decision will be whether to hike interest rates into positive territory. Once that decision has been made, the size of the hike will need to be decided.

Several of the Central Bank Governors and Presidents and Heads of Government are pointing to the fact that inflation is being driven by influences outside the ECB’s control, and even a hike of two hundred and fifty basis points won’t solve the issue.

That is almost certainly true but with core inflation also continuing to grow, the more hawkish nations of the Eurozone expect higher interest rates to provide a certain amount of comfort to savers and pensioners.

The Bundesbank is at the forefront of the group of nations pushing for a fifty-point hike next week, but in a similar fashion to the Fed’s future actions, it will be what happens at subsequent meetings that drives markets.

The other major discussion point at the meeting will be the introduction of the tool to ensure that debt issuance doesn’t become fragmented.

Fragmentation occurs when the gap in the spread charged between the strongest and weakest issuers blows out to a level which is considered unreasonable. Germany is the benchmark issuer, and all others are so many basis points above that.

It is dangerous to try to manipulate market forces, and the ECB has only just extricated itself from being the only buyer of paper issued by countries who are unable to attract sufficient interest.

Italy is the most prominent example. Not only is it unable to stay within Brussels’ guidelines about budget deficit and debt to GDP ratio, but it is also in a state of political turmoil.

It had been hoped that the triumphant return from Frankfurt of Mario Draghi as a uniting force would solve several issues. Unfortunately, that has not been the case and the country returns to the polls three weeks from Sunday with the right wing Five-Star Movement favoured to be voted into power.

The Euro also suffered at the hand of a stronger dollar yesterday. It fell to a low of 0.9910 but recovered to close at 0.9946.

A lot will depend on how hawkish Christine Lagarde is prepared to be at her press conference next week. She cannot afford to hint at a halt to rate hikes, as that could send the single currency into free-fall.