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Second U-turn and new Chancellor Hunt leaves sterling investors unsure

Sterling remains at the mercy of political developments in a fast-changing economic policy environment. Speculation was rife that further policy reversals were in the pipeline following the turnaround in the cut to the highest earner income tax. Prime Minister Truss ruled out cuts in public sector spending; the government was left with only a narrow range of choices to put the budget on a more sustainable path. 

On Thursday evening, Truss summoned Chancellor of the Exchequer, Kwasi Kwarteng back from the IMF meeting in Washington to replace him with Jeremy Hunt. She reinstated the planned rise in corporation tax but kept the other tax cuts announced, including the reduction in National Insurance.

Earlier in the week, the Bank of England threw more wood on the fire as they stated they would cease their Gilt operation and that pension funds needed to ensure they carried out their rebalancing by Friday. Some interpreted this as a threat towards the government, which appears to have worked, given recent actions. However, it will be interesting to see what happens if we see gilt yields climb again. 

Looking at the economic data, key inflation reading and consumer spending will hit the wires. The headline consumer price index inflation indicates a rise to 10.2% in September, a new high for 2022. Core inflation (excluding food & energy) indicates a rise to 6.6% from 6.3% and may further broaden inflationary pressures.

The UK’s retail sales will release on Friday. Given the current economic backdrop and rising mortgage rates, it would be no surprise if retail sales fell again. However, economic data may well be overshadowed by political developments and how these could potentially impact the BoE’s meeting at the beginning of November. 

Lastly, Chancellor Hunt will deliver an emergency statement this afternoon in a move to stabilise the market; he will bring forward “measures from the Medium-Term Fiscal Plan” – due on 31 October.

Data justifies US dollar strength

The US dollar gained against GBP and the EUR amidst a challenging backdrop. The gains against sterling were due to UK financial systems’ fragility following last night’s comments from BoE Gov Baily. In the meantime, gains against the single currency came from intensified military action between Ukraine and Russia. Russia launched a high number of missiles at cities across Ukraine. Although many were intercepted, there were still a large number of strikes, with markets uneasy over the threat of further escalation.

Minutes from the September Fed meeting stated that many participants consider the risks of doing too little outweighed the cost of doing too much. Still, there were also comments that it would be appropriate to slow the rate hikes and assess developments at some point. Several members emphasised the importance of maintaining a restrictive stance for as long as necessary, but other comments countered risks would become more two-sided as policy became more restrictive. There were hints of growing divisions within the committee but an ongoing commitment to a restrictive policy stance. That said, economic data justified the strength of the US dollar as inflation pointed higher whilst consumer confidence improved despite retail sales missing the target.

Looking to the week ahead, economic data is lighter, with the focus on manufacturing data from the Empire State and Philadelphia during the week. In the meantime, as always, markets will keep a close eye on comments from central bankers.

Single currency remains under pressure due to ongoing conflict 

The single currency was under pressure following intensified military action between Ukraine and Russia. The Euro-Zone Sentix investor confidence index dipped further to -38.3 for October from -31.8, weaker than consensus forecasts of -34.7 and the lowest reading since May 2020. However, the latest data on gas storage levels in Europe was more encouraging, with mild weather allowing a further increase, lessening immediate fears surrounding this winter. On the whole, economic data was light from the region, leaving the single currency trading behind risk trends against the greenback.

Looking to the week ahead, economic data remains light, with only the German ZEW and consumer confidence due. Tuesday’s German ZEW will likely show a further decline in economic sentiment. Friday sees the release of the consumer confidence reading, set to show a decline. However, like sterling, the currency is driven by more significant underlying matters which could see fast developments and inject further volatility.

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