Sterling slumped to a record low

Chris Scicluna
Emily Nicol

Gilts smashed again after sterling hit new low in Asian time following weekend signal of further UK tax cuts to come
While Friday’s UK fiscal announcement of larger-than-expected unfunded tax cuts sent sterling and Gilts reeling, yesterday’s insistence by Chancellor Kwasi Kwarteng that there will be further tax cuts to come in the New Year has provided further negative impetus this morning. After sterling hit a new record low against the dollar of $1.035 in Asia time, it has since returned close to $1.07. But Gilts have been smashed again, with 2Y yields up more than 40bps from last week’s close to above 4.30%, taking the cumulative increase since before Friday morning’s mini-Budget statement to roughly 90bps. The OIS market is now pricing a hike in Bank Rate of 100bps at the BoE’s November policy meeting, and we certainly agree that looks a sensible bet. Of course, given the inflationary impact of the weak pound, should sterling take further steps lower in a disorderly manner, the MPC might well have to hike before than meeting arrives to try to stem the tide.

With the UK firmly reliant on the kindness of strangers to fund its gaping twin deficits, Friday’s current account data for Q2 will be of big interest. The current account deficit deteriorated to a record 8.3% of GDP in Q1. And while that in part was largely caused by the soaring price of energy imports following Russia’s invasion of Ukraine, and the trade data point to a modest narrowing in Q2, the balance of payments will still leave sterling and Gilts vulnerable to further marked correction. Alongside these data, final Q2 GDP figures are expected to confirm a contraction of 0.1%Q/Q, likely to be followed by a further contraction this quarter. Ahead of these data, we will get the BoE’s latest bank lending numbers (Thursday), which are expected to confirm that demand for consumer credit remained firm in August as household budgets continue to be squeezed by high inflation. Indeed, the BRC’s shop price index (Wednesday) seems bound to flag elevated price pressures on the High Street, not least due to higher global food prices, with the headline rate likely to have risen further from August’s series high of 5.1%Y/Y.

Italian spreads wider after right-wing coalition on track for majorities in both houses of parliament
While far more stable than Gilts, spreads of BTPs over Bunds are wider this morning – up almost 10bps at the 2Y mark and about 6bps at the 10Y – after yesterday’s Italian general election went broadly as the polls suggested. With the right-wing coalition looking set to win about 43% of the vote, it appears firmly on track to win majorities of seats in both houses of parliament. Moreover, with the nationalist Brothers of Italy seemingly having won roughly one quarter of the vote, it will comfortably have more seats than their two partners (Salvini’s Lega and Berlusconi’s Forza Italia, with little more than 8% of the vote apiece) combined. So, their leader Georgia Meloni is set to succeed Mario Draghi as Italian Prime Minister. And the strong showing of the Brothers of Italy should enable Meloni to face down Salvini on policy, with the latter having called for another big fiscal package, of about €30bn, to support households and businesses cope with higher energy bills, in contrast to the former’s desire to maintain a broadly stable fiscal stance.

Japanese flash PMIs flag ongoing challenges despite modest improvement in services activity
Contrasting with last week’s downbeat euro area flash PMIs that signalled a steeper pace of contraction at the end of Q3, today’s Japanese surveys implied a modest rebound in the economy amid the further relaxation of Covid-19 restrictions. Indeed, the headline composite PMI rose 1.5pts to 50.9, with the new business component up 1.6pts to 51.0, reflecting a marked improvement in the services sector, with the activity PMI up 2.4pts to 51.9 and the new business index up 2.9pts to 52.8. Admittedly, these measures were merely their highest since June. And services firms’ expectations about the year ahead were the weakest for six months. Furthermore, manufacturers continued to flag challenges in the sector, with the output PMI down for the sixth consecutive month to 48.9, the lowest for a year, and the new orders index (47.0) down to its lowest for two years. And with the impact of the Typhoon Nanmadol unlikely to have been fully reflected in this survey (conducted between 12-21st September), we might well see a further deterioration in conditions in the sector.

This notwithstanding, the latest IP numbers for August (due Friday) are expected to post a third consecutive monthly increase (0.2%M/M), to leave them on track for a notable rebound in Q3. Friday will also bring the latest retail sales, consumer confidence and labour market figures. Despite higher prices, nominal retail sales are forecast to have risen just 0.2%M/M, reflecting not least historically weak consumer confidence. Nevertheless, confidence is expected to have risen for the second successive month in September, while the unemployment rate is forecast to have fallen slightly, by 0.1ppt to 2.5% in August.

Euro area inflation set to hit new high on Friday, ifo survey to add to evidence of German recession today
This week is set to be a busy one for top-tier euro area economic data releases, with most notable being Friday’s preliminary euro area inflation figures, which are set to mark new record highs. In part due to the expiration of the German discounted travel pass and fuel duty cut, we forecast an increase of 0.7ppt in the headline HICP rate to 9.8%Y/Y. While this will also partly reflect higher food inflation, we think that core inflation could also rise to as high as 5.0%Y/Y, from 4.3%Y/Y previously. The flash member state numbers from Germany and Spain, due Thursday, should provide a guide as to what to expect.

Ahead of these key inflation data, the week’s euro area dataflow gets underway with the September German ifo business survey this morning. If Friday’s flash PMIs are anything to go by, the ifo indices should add to evidence of recession in the euro area’s largest member state. Other survey data due this week include Thursday’s Commission survey, which will also likely echo the deterioration in the flash PMIs and also confirm the record low in consumer confidence reported in the flash estimate. In addition, the latest labour market data (also Friday) should remain a rare source of comfort, with the euro area unemployment rate expected to have moved sideways at a record-low 6.6% in August. Amongst the deluge of ECB-speak due this week, later today President Lagarde will give her latest quarterly economic update to the European Parliament’s Economic and Monetary Committee. And on Thursday, relatively dovish Chief Economist Lane is due to speak on inflation at a Fed-sponsored conference, while key Executive Board hawk Schnabel is due to speak on Friday.

US spending, consumer confidence, and housing market indicators among a busy week for US data
A busy week for US data concludes arguably with the most noteworthy, the monthly personal income and spending numbers for August. Hourly earnings suggest only a modest increase in wages and salaries in August – our colleagues in Daiwa America forecast growth of just 0.1%M/M. While vehicle sales and retail spending numbers point to a drag from spending on goods, overall expenditure might well be boosted slightly by services – Daiwa’s expectations is for growth of 0.3%M/M. But this in part will continue to reflect higher prices, with the core PCE price index expected to rise a further 0.5%M/M, slightly firmer than the average over the past year. Friday will also bring the revised University of Michigan consumer sentiment survey, including updated estimates of household inflation expectations. Ahead of this will bring the Conference Board’s consumer confidence survey (tomorrow), durable goods orders numbers (also tomorrow), advance goods trade figures (Wednesday) and updated Q2 GDP data (Thursday). Various housing market indicators are also due, including new home sales, FHFA and S&P CoreLogic home price indices (tomorrow), and pending home sales (Wednesday).

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