It is no secret that the UK economy has been facing headwinds. The week, however, things took a turn for the worst, as the UK’s finance ministry delivered an extremely controversial mini budget.
Key themes for this week include:
- The Bank of England (BoE) launches emergency bond buying programme
- European Union (EU) economic sentiment slides to a two-year low
- EU equity selloff ensues
- Oil struggles to gain momentum
FINANCE MINISTRY ACTION IN CONTRAST TO BoE OBJECTIVES
Last week, UK Chancellor of the Exchequer, Kwasi Kwarteng, delivered a controversial mini budget, citing tax breaks as a key pillar. While the UK government is trying to relieve the economic burden felt by consumers, markets did not take kindly to this move. It is widely believed to be political in nature, rather than serving in the best interest of the UK economy.
Former governor of the BoE, Mark Carney, did not hold any punches as he criticised the move by government to try and stimulate short term growth in a period where the Central Bank is also desperately trying to reign in high levels of inflation. In an interview with media, Carney outrightly rejected the notion that the turmoil over the last week was a global phenomenon. He said, “In the case of the last week, developments have centered around the UK.” He also proceeded to criticise the Chancellor for “undercutting” institutions such as the Office for Budget Responsibility and Treasury.
The former governor, however, was not the only one to express his disdain for the partial budget, as investors spoke with their money. A significant sell-off was launched in the UK, sending a loud and clear message that tax cuts and fiscal spending, in this environment and without a plan on how these cuts will be funded, will be harshly penalised.
On Wednesday, the BoE, took emergency action to stabilise the UK’s financial markets. The Central Bank said it would buy long-term government bonds over the next two weeks to combat a recent slide in British financial assets. The Bank’s actions are focused on long-term government debt, where yields have soared in recent days, pushing up government borrowing costs. The bank was quoted by media as saying, “Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability.” It added, “This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.’’
Following the recent discontent between monetary and fiscal policy, many investors are viewing the UK economy as an emerging market rather than a developed one.
DATA IN A NUTSHELL
The United States (US) economy contracted by an annualised 0.6% quarter-on-quarter in the second quarter of 2022, matching market estimates and, following the 1.6% contraction in the first quarter of the year, confirming a technical recession. Private inventories and fixed investment were the main draggers in the second quarter. Meanwhile, the GDP growth rate for 2021 was revised higher to 5.9% compared to an initial 5.7%. In addition, the economy contracted 2.8% in 2020, less than an initial reading of 3.4%.
The economic sentiment indicator in the euro area slumped 3.6 points in September – from a month earlier, to 93.7, its lowest level since November 2020 and below market expectations of 95.0. Sentiment has fallen amid concerns over rising inflation and interest rates, as well as a weakening economic outlook and an intensifying energy crisis due to the war in Ukraine.
Industrial profit in China declined by 2.1% year-on-year to ¥55.25 trillion in the first eight months of the year, a much sharper decline than the 1.1% drop in the previous period. This comes amid strict COVID-19 curbs in several key economic hubs, a weakening yuan, and a further slump in factory activity due to severe heatwaves. The latest reading represents China’s worst rate of industrial profits in two years, as the momentum of economic recovery continues to be negatively impacted by a variety of unexpected external factors, including the country’s current zero-COVID policy.
South Africa’s private sector credit increased by 7.86% year-on-year in August, beating market expectations of 6.8% and following a 7.06% growth in the previous month. This marked the 14th consecutive month of growth in private sector credit and its steepest pace since April 2019. Meanwhile, an increase in the broadly defined M3 measure of money supply grew 8.15% in August, the same pace as in July, and above consensus of 7.9%. South Africa’s annual producer inflation eased to 16.6% in August, from a peak of 18% in July, and below market expectations of 17.7%. On a monthly basis, producer prices were up 0.5%, their smallest increase in seven months, and slightly above market forecasts of a 0.4% rise.
NO REPRIEVE FOR STOCKS
The Dow Jones Industrial Average lost more than 500 points on Thursday, while the S&P 500 and Nasdaq lost 2.4% and 3.1%, respectively, amid persistent fears of tightening financial conditions and slowing economic growth. A higher-than-expected inflation reading, with core Personal Consumption Expenditure (PCE) prices for the second quarter coming in above expectations, raised concerns that inflation is becoming even more entrenched. At the same time, better-than-expected jobless claims numbers painted a picture of an economy that can likely withstand more fiscal tightening. Hawkish views adopted by several US Federal Reserve (Fed) policymakers about the battle against inflation, has exacerbated angst in markets. This quarter, the Dow Jones and S&P 500 are on track for their third consecutive quarterly loss, for the first time since 2015 and 2009, respectively.
The UK’s blue-chip FTSE 100 sank almost 2% on Thursday, dragged down by utilities and real estate stocks. Sentiment was dominated by concerns over the pace of interest rate increases to tame inflation and the impact of the UK’s current fiscal policy on global economic growth. The BoE reignited quantitative easing to stabilise the gilts market, following the turmoil brought about by the Chancellor’s tax cuts and borrowing plan.
European stocks suffered another round of losses during afternoon trade on Thursday, with the DAX losing nearly 2% and the STOXX 600 shedding 1.5%, following the release of fresh German data, which indicated that the inflation rate increased by more than expected in September, topping double-digits. This has added to concerns that the European Central Bank (ECB) will need to make bigger rate hikes to tame surging inflation. This, at a time, when the economy is already limping along.
The South African JSE FTSE All Share Index slipped 1% to an over one-year low of 62,829 on Thursday, extending losses for a second day. The bourse was mainly dragged down by financials and industrials. Investors continued to monitor risks to the global economic outlook, against a backdrop of elevated inflation and higher interest rates, as well as escalating tensions between Russia and Western countries.
ECONOMIC SLOWDOWNS HALTS DEMAND
Brent Crude futures tumbled more than 2% to around $87/barrel, pressured by persistent concerns over a global economic slowdown and the subsequent demand glut. A stronger dollar is also exacerbating the bearish drive. The US oil benchmark, the West Texas Intermediate, is set to decline for the fourth straight month, while heading for its first quarterly loss in more than two years. However, an escalating energy standoff between the EU and Russia threatened to disrupt supply. Meanwhile, weaker crude prices prompted speculation that the extended Organisation of Petroleum Exporting Countries, OPEC+, could announce another production cut next week. Official data also showed that US crude inventories unexpectedly dropped last week, their first decline in a month.
Gold prices remained subdued this week, easing towards $1 650/ounce on Thursday after a sharp rebound in the previous session. Gold prices are being dragged down by safe haven demand for the dollar. The metal is on track to decline for the sixth straight month as the US Fed led a global wave of interest rate hikes to curb surging inflation, which has dented the appeal of non-yielding bullion. Investors also prefer the dollar over gold as a safe store of value amid the heightened economic uncertainties and given the US economy’s strength relative to other developed nations. Gold prices did jump nearly 2% on Wednesday after the BoE said it would purchase bonds in a bid to stabilise its financial markets, which sent the dollar and global bond yields lower, while pushing the gold price higher.
Copper futures weakened toward $3.30/pound as we head towards the end of September, their lowest level in two months. They are being weighed down by aggressive monetary tightening around the globe that has dampened metals demand. Economic uncertainties in top metals consumer China, also weighed on sentiment after global financial services groups, Nomura and Goldman Sachs, lowered their growth forecasts for the country, citing expectations that its strict zero-COVID strategy would extend well into next year. Meanwhile, analysts are sounding the alarm on a massive shortfall in copper supply in a few years due to an expected surge in demand from the shift towards clean energy. The recent downturn in prices, and the under-investment that ensues, also threaten to exacerbate the scenario, according to a Bloomberg report.
DOLLAR’S PAUSE SHORT LIVED
The US Dollar Index rebounded to above 113 on Thursday, after tumbling more than 1% in the previous session, heading back towards its highest levels in two decades. Fresh data showed weekly US jobless claims fell to a five-month low, while PCE prices, that were revised higher in the second quarter, helped fuel dollar strength. Continuous Hawkish remarks from Fed officials and the rejection of a possible currency agreement among major economies also supported the dollar. Throughout the week, numerous Fed policymakers indicated the Central Bank’s determination and commitment to do what is necessary to bring down inflation, even at the risk of a recession and further market volatility. Meanwhile, White House National Economic Council Director, Brian Deese, rejected the idea of another 1985-type currency accord to weaken the dollar and added that the US economy’s relative strength was a significant factor driving the dollar higher.
The euro traded above $0.97, appreciating from a 20-year low of $0.95 hit earlier in the week, as investors react to the first round of inflation data ahead of Friday’s euro area release. Preliminary data indicated that Germany’s annual inflation rate accelerated, more than expected, to an all-time high, but that Spain’s eased for a second month. ECB President, Christine Lagarde, recently reinforced the view that the ECB must keep hiking interest rates to cool inflation. The euro is down 20% so far this year, pressured by a stronger dollar, as the Fed continues to deliver big interest rate hikes, and as the probability of a recession in the EU intensifies due to the energy crisis.
The British pound was trading around $1.08, rebounding from its recent lows, but remains uncomfortably close to levels not seen since 1985, as investors worry over a new tax cut plan, soaring debt levels, high consumer prices, and a looming recession. While the Chancellor of the Exchequer said his £45 billion in tax cuts would support the economy, the IMF noted the strategy is likely to increase inequality, and ratings agency, Moody’s, warned that unfunded tax cuts would be seen as credit negative. Money markets have also priced in about 160 basis points of rate hikes at the Central Bank’s next meeting.
The South African rand depreciated towards a low of R18.25/$ on Wednesday, before recouping some of the losses it suffered due to the spillover of UK’s economic turmoil, and remains near its weakest levels since May of 2020. The South African rand also faces local headwinds, brought on by intense loadshedding which is dimming the outlook of economic growth. In the short term, risk for further weakening of the rand persists, with many warning that the rand could approach the R19.00/$ mark should the upward dollar momentum continue.
The rand is trading at R17.97/$, R17.65/€ and R20.02/£.