More Pain on The Way
MARKETS REMAIN FOCUSED ON INFLATION RISKS Another volatile week in markets saw equities first rise but then slip after a worsethan-expected US August inflation report on Tuesday. That showed annual US CPI inflation down modestly from July, reflecting lower petrol pump prices, but the fall was less than forecast, while ‘core’ inflation also rose. Possibly of most concern were indications that ‘core’ inflation is increasingly being driven by rises in service sector prices in part due to pressures stemming from the tight labour market. That was seen as a sign that inflationary pressures may prove more enduring. On Wednesday, UK August inflation data posted a similar message with headline inflation down from July but the ‘core rate’ up due to rising service sector inflation. Bond yields rose further in the wake of this news. In the US, Treasuries have now completely unwound their early summer rally as both 2-year and 10-year yields posted new highs for the year. In the UK, yields also touched new 2022 highs. Meanwhile, in currency markets the US dollar has continued to climb, while sterling has been under selling pressure as it notched up new 2022 lows against both the dollar and the euro.
FED TO HIKE BY 75BP FOR THIRD MEETING IN A ROW
Monetary policy updates from the US Federal Reserve and the Bank of England are likely to be the key focus for markets in the coming week. Markets expect both to raise interest rates again although there is some uncertainty over how much. In the case of the Fed, market speculation for much of the period since the last policy meeting in August has centred on whether it would opt for a third successive 75 basis point hike or a smaller 50bp increase. However, hawkish comments from Fed Chair Powell just before the central bank went into its blackout period and this week’s inflation data have convinced markets that a move of at least 75bp is a near certainty. Indeed, market pricing suggests there is a strong risk of a 100bp hike. Equally important will be what the Fed signals about its future policy intentions. Overall, the Fed’s message is likely to remain that getting inflation under control is the number one priority and so further rate hikes are likely. This is one of the meetings where Fed policymakers update their forecasts, including the ‘dot plot’ of interest rate projections. The last set in June showed a median expectation of rates reaching close to 3.5% by end 2023 and peaking just below 4% in 2024. Given that a 75bp hike would take the upper bound of the Fed Funds range to 3.5% on Wednesday it seems likely that these projections will be revised in line with current market expectations of close to 4% by the end of 2022 and a peak close to 4.5% by the middle of next year.
MARKETS EXPECT BOE TO RAISE RATES AGAIN
The BoE’s September policy update was originally planned for this Thursday but was delayed by a week because of the Queen’s funeral. Market expectations are centred on a second 50bp rate rise. The previous voting pattern on the MPC wasn’t unanimous, and this time may again see a split. Speculation beforehand is that one Monetary Policy Committee member may again vote for a smaller 25bp rise, but that others may favour a larger 75bp hike this time. Of key interest will be the BoE’s initial thoughts on the implications for monetary policy of the government’s announcement of measures to cushion the impact of rising energy prices. These will mean that inflation is likely to peak well below where the BoE’s envisaged at the time of its last update in August. However, the substantial fiscal stimulus will add to demand pressures at a time when domestic inflation is already very high. It seems likely that the BoE will opt not to take a strong position for now on whether this means that rates should rise by more or less than previously assumed. Instead, it may message that it is waiting for more detail on the fiscal outlook and that it will update its forecasts in time for its next update in November. In the meantime, it will probably retain previous guidance that rates are not on a pre-set course and that the path is ‘data dependent. Friday is scheduled to see further news on the fiscal front with what is being called a ‘fiscal event’. This is not a full budget and new forecasts from the Office for Budget Responsibility are not expected. Media reports suggest that it will be based around the promises made by the PM during her leadership campaign. These include reversing the rise in national insurance contributions made in April and a jettison of the commitment to raise corporation tax next year. More details may also be provided on last week’s energy support announcements. Finally, there is speculation that Chancellor Kwarteng will emphasise a commitment to focusing on economic growth rather than austerity, asserting that the higher revenue generated will help improve the public finances.
UK PMIS TO SIGNAL DOWNSIDE RISKS TO GROWTH
The coming week’s light data calendar seems likely to be overshadowed by the policy events. Possibly of most interest will be the September PMI data which we expect to show further weakness in both the UK and the Eurozone. In the UK, we forecast the headline services reading to fall below 50 for the first time since February 2021 reflecting a growing impact from weakening demand. Meanwhile, the headline manufacturing reading is forecast to stay below 50 for a second consecutive month. That points to the composite UK PMI measure also being below 50 for a second month in a row. The Eurozone is expected to see both the manufacturing and services measures fall further below 50. Finally, the GfK’s UK consumer confidence measure may see a small rebound in September from August’s record low reflecting a positive initial response to the energy package.
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