An Air of Expectation

EXPECTATIONS OF A NOVEMBER HIKE ‘FINELY BALANCED’ UK bond markets reacted to hawkish-sounding comments from BoE Governor Bailey in which he said that the Bank “will have to act” to curb inflation. Chief Economist Pill said that UK inflation could rise slightly above 5% early next year. Also, that next month’s policy decision is “live” and “finely balanced”. Short-dated gilt yields, which are sensitive to changes in official interest rate expectations, gapped higher, with the 2-year yield jumping up to around 0.70%, compared with just 0.20% at the start of September. Markets are fully priced for a 15bps rise in Bank Rate to 0.25% by November, with four further quarter-point increases next year to 1.25% by the end of 2022. Higher UK interest rate expectations have provided limited support for the sterling exchange rate, although the pound has not broken through the $1.40 level since June.

CHANCELLOR SUNAK EXPECTED TO BE CAUTIOUS The Autumn Budget and Spending Review (Wed) will be next week’s main UK focus. A key question is whether economic upgrades and better borrowing figures provide room for Chancellor Sunak to offer significant giveaways. The answer is probably not. Here are the main economic details to look out for: i) The economic growth forecast for 2021 by the independent Office for Budget Responsibility (OBR) is likely to be revised up significantly from its cautious 4.0% forecast back in March. The Bank of England, for example, predicts growth of 7¼%. However, the OBR is likely to lower its growth expectations for 2022. Overall, though, less economic scarring than expected may point to an earlier return to pre-pandemic output levels (previously at Q2 2022) and more positive medium-term assumptions.

ii) Government borrowing for the first half of the 2021/22 financial year has undershot the OBR’s most recent projection by £43bn, thanks mainly to stronger-than-expected tax receipts. Borrowing for 2021/22 is expected to be below the March prediction of £234bn, and will probably be nearer £200bn, down from £320bn in 2020/21.

iii) Much has been made of the OBR’s new forecasts being based on the old vintage of GDP data (the cut-off was 24 September) which painted a less positive picture of the economy than the very latest data. That suggests there may be more fiscal headroom than might be indicated in next week’s updated OBR projections. However, market interest rates (which raise the cost of borrowing) have also risen sharply in recent weeks.

iv) Overall, despite better-than-expected public finances, the Chancellor is expected to be cautious, especially with the impact of higher inflation and interest rates on debt servicing costs. According to reports, the Chancellor could announce new fiscal targets to achieve a balanced current budget in order to control government borrowing.

v). There may be some limited giveaways, including reports that the government’s coronavirus loan guarantee scheme for businesses may be extended and a possible VAT cut in energy bills. There may also be announcements surrounding the transition to net zero. The weekend press may contain further hints. The bottom line, though, is that the Budget is expected to be broadly fiscally neutral.

ECB ON HOLD DESPITE RISING INFLATION

In the Eurozone, the ECB will deliver its policy update (Thu). There may be some hints on what might replace the Pandemic Emergency Purchase Programme (PEPP) after next March, but details are expected to be provided at the December meeting. What will be interesting is what President Lagarde says about prospects of significantly higher inflation in the short term than it predicted only in September. So far, she and many ECB officials have sounded relatively relaxed and more comfortable with the ‘transitory’ argument than other central banks (notably the Bank of England). We expect the latest Eurozone ‘flash’ CPI for October (Fri) to increase to 3.6%y/y, well above the ECB’s new symmetric 2% target, driven mainly by energy prices. Core inflation, excluding food and energy, is forecast to stay at 1.9%y/y. The first estimate of Eurozone Q3 GDP (Fri) is also released. We forecast a rise of 2.0%q/q, similar to the pace of expansion in Q2 (2.1%q/q). That would leave the Eurozone economy on track potentially to return to its pre-pandemic GDP level in the fourth quarter. The German IFO business survey (Mon) will provide an update on business confidence at the start of Q4.

US GDP GROWTH TO SLOW

The US economy has already retraced its pandemic output declines. However, we think Q3 GDP growth (Thu) slowed to around 3.5% (annualised rate) from 6.7% in Q2. The market consensus forecast is 2.4%. Also out are September personal spending data (Fri) to give a sense on how consumption unfolded through the quarter. Consumer sentiment remains near recent lows, as households face shortages and higher prices. The Fed’s preferred inflation gauge, the PCE deflator, is expected to edge up to 4.4%y/y in September from 4.3%y/y, the highest since 1991.

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