The UK gilt market reaction to yesterday’s budget was a benign one in contrast to the reaction of the Kwarteng budget, which perhaps wasn’t too surprising given that most of it had been briefed out beforehand.
We did see some initial sterling weakness, but a lot of that was down to US dollar strength after St. Louis Fed President James Bullard said that the central bank needed to go much further in raising rates, saying that to really get a handle on inflation the terminal rate had to rise to between 5% and 7%. This is much higher than the current target level for markets of 3.75% to 4%.
Unsurprisingly US markets finished lower for the second day in a row on the back of these comments, albeit well off their lows of the day, as yields also shot higher, with the US 2 year and 10-year yield both reversing from 6-week lows.
Bullard’s comments are all the more surprising given that there is clear evidence that inflationary pressure is starting to slow more than expected. Consequently, Bullard’s views may well be a minority view at this point, but it still shows how sensitive markets can be when it comes to the eventual destination of the terminal rate.
The stronger US dollar did bring some good news in the form of lower oil prices, with demand concerns also weighing on prices due to a continued rise in Covid cases across China.
The recovery off the lows of the day in the US looks set to see markets here in Europe open modestly higher with the focus today remaining on the UK economy, with the latest October retail sales numbers.
Yesterday, we heard Chancellor of the Exchequer Jeremy Hunt describe high inflation as the enemy of stability, while at the same time freezing tax thresholds for the next 5 years, at a time when inflation is not expected to fall below 7% until 2024 according to the OBR.
The OBR also went on to say that the UK was already in recession and that the next two years would see a drop in disposable incomes of 7% for UK consumers, as well as a 9% fall in house prices. That will be a huge drag on demand for an economy that is largely consumer driven.
When looking through the fine print of the budget that figure on house prices seems somewhat optimistic, which is perhaps why the Chancellor kept the stamp duty cut until March 2025.
As we look towards the end of the year, the pressure on the UK consumer is unlikely to diminish, although we could well see a pickup in retail sales spending in the lead-up to Christmas.
Not for nothing has the last two months seen some poor retail sales numbers, with declines of -1.7% in August and -1.4% in September.
With the new energy price cap kicking in at the beginning of October it’s not hard to see that consumers have been curtailing spending due to uncertainty over the lead up to the price rise, as well as the political shambles that played at Westminster over the end of September and the beginning of October.
While the September numbers were weighed down by the extra Bank Holiday due to the funeral of Queen Elizabeth II, today’s October numbers aren’t expected to see that big an improvement, although a rise of 0.5% is expected.
With consumer confidence already at or close to record lows, it’s likely that consumers, if they do have money to spend, are probably holding back ahead of the end of the year and the Christmas period.
EUR/USD – continues to find the air thin above 1.0400 and the 200-day SMA at 1.0440. A close above 1.0430 is needed to push up towards the 1.0600 area. Support all the way back at the 1.0180 area.
GBP/USD – dipped as low as 1.1760 yesterday before rebounding and is currently struggling to move beyond 1.1960. The 1.2030 area remains the broader resistance. This is likely to be a huge barrier for any further gains. Support remains all the way back at the 1.1640/50 area.
EUR/GBP – continues to chop between resistance at the 0.8820/30 area, with support still at or around the 0.8690 area.
USD/JPY – need to overcome the 141.00 area to minimise the risk of a move back to the recent lows at 137.65.