7 November 2022: UK was ‘hours from meltdown’

GBP – Sentiment falling as inflation rises

When Liz Truss and her Chancellor Kwasi Kwarteng announced their mini-budget containing a series of unfunded tax cuts, it caused such alarm in the markets, especially amongst pension funds, that the Bank of England was forced to step in.

Andrew Bailey, the Bank’s Governor, held talks with representatives from the hours of having to implement emergency plans for a market meltdown. Treasury, Bank Chairmen, and the Office for Budget Responsibility to try to have the measures reversed, considering what they could see happening in real-time,

Representatives of the OBR, whose report on the effect of the measures was ignored and remained unpublished, met with Kwarteng as they tried to impress on him the gravity of the situation.

Although the UK economy is now sailing in calmer waters, the issue of balancing the books remains and is due to be addressed by Chancellor Jeremy Hunt next week when he presents a full budget that has been produced with full input from the OBR.

It is expected that the £60 billion hole in the Government’s finances will be closed by making cuts to public services and a series of tax increases. The split is believed to be £25 billion of tax increases and £35 billion of spending cuts.

There is still speculation regarding the triple lock on state pensions, which is sacrosanct by senior members of the Conservative Party.

The Bank of England finally made a significant attempt to try to bring inflation under control last week by hiking short-term interest rates by seventy-five basis points. In its efforts to be as transparent as possible, the Bank has lost the ability to surprise.

The pound gained little ground and would fall if the bumper rate hike did not materialise.

The economy is likely to enter a recession which Bailey expects to last into early 2025. The Conservative Party government faces the possibility of its majority being wiped out by an electorate that feels the Conservatives have failed to deliver on their promises.

Last week, Sterling could not continue its push through the resistance at 1.1645 and fell to a low of 1.1147 and closed at 1.1376.

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USD – New Year recession still in the balance

The prospect of a recession in the United States will weigh heavily on voters’ minds as they cast their ballots in the midterm elections that will take place tomorrow.

Donald Trump, who is trying to be perceived as the leader of the Republican Party to make himself unassailable for the 2024 Presidential Nomination, and the incumbent, Joe Biden, crisscrossed the country over the weekend, lending their weight to candidates in several Swing States,

Both ended up in Pennsylvania, the scene of the most contentious battle in the 2020 election and considered a vital seat tomorrow.

The October Employment Report was published on Friday, and not only did the jobs market remain strong, but the September headline was revised from 263k to 315k.

261k new jobs were created in October, significantly more than the 200k that had been predicted. The unemployment rate nonetheless rose from 3.5% to 3.7% but remains well below the old measure, which says that the U.S. is close to full employment if the unemployment rate remains below 5%

On the strength of the data, the Fed was justified in hiking rates by a further seventy-five basis points last week.

The percentage of votes who believe the economy is heading for a recession has dropped following the data but remains above 50%.

The market is already focussing on the next FOMC meeting, which will take place on December 13/14. However, the minutes of the latest meeting will be published on November 23rd. Investors will closely study them for any deviation from the hawkish path that the Central Bank has been following for the past six months or so.

The dollar attempted to rally off the back of the FOMC meeting and the Employment report but lacked momentum. It reached a high of 113.14but fell back to close unchanged on the week at 110.78.

EUR – Lower dividends & boardroom representation – a step too far

Banks in several countries of the Eurozone are reacting badly to the level of oversight being placed on them by the ECB.

The most unpopular new regulation that has been brought in is the Central Bank insisting that it is represented at board level. While limiting dividend payments and trader’s bonuses was just about acceptable, several banks have made representations to Frankfurt.

They feel they are being made scapegoats of the ECB’s inability to first support the economy and then bring inflation under control.

Data released last week all but confirmed that the Eurozone is facing a tough winter as it slips into a recession. Although the composite PMI improved slightly from 48.2 to 48.6, it remains well below the fifty level which denotes expansion.

After a weak third quarter which saw both GDP and PMIs continue to weaken, the Eurozone economy appears unable to avoid a recession which may have already started.

With officials having almost abandoned the use of the traditional method of deciding a recession, unless it suits them, the fact that GDP has slumped so much this year as inflation continues to rise, should be sufficient to say that the economy is in recession.

If the ECB forces the market to wait for two consecutive quarters of contraction, then the recession will be declared in March of next year. Probably, the Central bank will still be in a tightening phase by then.

The fear amongst the Central Bank’s top officials is that inflation becomes entrenched. A measure of that will be when wage claims become linked to inflation. The fear is that a vicious circle begins that quickly becomes impossible to escape from.

With the economy facing a period of stagflation, when there is little or no growth in the economy, but prices continue to rise makes it easy to understand why the ECB is so determined to win its battle to drive inflation lower.

With Germany, the largest Eurozone economy now in recession, other economies will continue to slow down as the war in Ukraine and rising energy bills hit the region.

The single currency came close to challenging parity versus the dollar last week, but again fell short. It closed at 0.9959, having topped out at 0.9979.