It’s been a relatively calm week in financial markets, notwithstanding a welcome surprise to the downside in UK inflation data, as well as a rate cut from the European Central Bank
Investors would be well advised to enjoy the calm, ahead of a busy period of central bank meetings, the UK budget and the small matter of elections in Japan and the United States.
Let’s start with the UK as we had updates on both inflation and unemployment this week. The UK inflation data showed for September at 1.7% year on year, lower than the 1.9% expected and down from 2.2% in August. This was the lowest level of CPI since April 2021. The easing in inflation was predominately thanks to lower petrol prices and air fares. Importantly, pizza and chocolate prices also saw notable falls(!) Core inflation was the weakest in three years at 3.2% vs 3.4% expected. Services inflation, which the Bank of England (BoE) has been closely watching, also saw a significant easing, mainly thanks to the declines in air fares. Services inflation is now 4.9%, from 5.6% previously. The downside surprise in the data leads to increased expectations for Bank of England rate cuts, with 114bps of cuts priced by June 2025. BoE Governor Andrew Bailey recently said the Bank could be “a bit more aggressive” in lowering borrowing costs if inflation continues to fall; this data boosts hopes the Bank will cut rates at both its November and December meetings despite base effects from energy prices likely to push inflation higher in the short term. The employment data also saw positive news for the BoE, with wage pressures easing somewhat. The UK unemployment rate fell slightly, to 4.0% while wages in the three months to the end of August rose year on year by 4.9% excluding bonuses and by 3.8% including bonuses. The direction of travel in wages will give the BoE additional confidence that they in a position to cut interest rates further.
Alongside the data, there continues to be plenty of speculation around the upcoming budget, with various (very large) numbers being floated around on the size of the tax increases/spending cuts set to be revealed by Chancellor Rachel Reeves on October 30th. The Financial Times reported that the Chancellor is looking to close a £40 billion funding gap in the Budget on 30 October. The figure is significantly higher than the £22bn fiscal hole previously identified by the government. The higher figure represents the funding that Reeves is seeking to protect key departments from real term spending cuts, to cover the £22bn overspend and build a fiscal buffer for the later years of their parliamentary term. The new ‘golden rule’ which balances day to day spending with tax revenues require significant savings and tax increases. The Chancellor presented her final budget proposals to the OBR this week. While the government has committed in their manifesto not to hike the ‘big four’ taxes – income tax, VAT, corporation tax and national insurance – collectively responsible for 75% of tax receipts, they will likely need to look in many places, including Capital Gains Tax to make up the fiscal shortfall.
Investors continue to ponder the size and scope of the Chinese economic stimulus packages that have seen plenty of promises made, but not a huge amount of detail, in recent weeks. A press conference last Saturday did little to help with the messaging light on specifics for immediate stimulus but firm on commitment. Chinese equities responded positively initially but have since resumed their downtrend, and both Chinese and Hong Kong indices are now in ‘correction’ territory having given back over 10% of their recent gains. The size of the stimulus package remains unclear though Finance Minister Lan Fo’an assured the audience the government would take “comprehensive measures” to achieve its annual goals. There were no announcements on measures to support consumption such as support for low income groups or unemployed or spending on the elderly/childcare. Fo’an said “we have other policy tools under study as well. For example, the central government still has considerable space for borrowing and increasing the deficit.” Later in the week the government did announce an expansion of a program to support unfinished property projects with additional loans to 4 trillion Yuan (USD 562 bn) from an already deployed level of 2.23 trillion yuan. China’s Housing Minister, Ni Hong, said at a briefing that authorities are “acting very swiftly” to stabilise the real estate market and “we can definitely win this battle to ensure the delivery of housing”. However, with around 150 million empty properties, arguably China does not need additional housing coming to the market and pushing pricing lower. Balancing supply and demand in the housing market remains crucial for longer term economic stability. China published Q3 GDP data this morning, with growth of 4.6%, which was slightly better than expected but very much at the bottom end of the annual growth target. Other data showed retail sales growing at 3.2%, boosted by government subsidies for household goods, while new home prices declined by 6.1% year on year. This was the 16th consecutive month of falling house prices. China’s central bank governor Pang Gongsheng said this morning the real estate sectors and stock market were key challenges in the economy that require government support.
The European Central Bank (ECB) meeting yesterday saw interest rates cut by 25 basis points to 3.25%. Recent soft economic data meant the decision was widely expected – eurozone PMI data is in ‘contraction’ territory and inflation, with CPI at 1.7% year on year in September, is below the central bank’s target. The ECB said the decision was based on an “updated assessment of the inflation outlook” with “the incoming information on inflation showing that the disinflationary process is well on track” and future expectations were “affected by recent downside surprises in indicators of economic activity”. ECB President Christine Lagarde downplayed concerns over economic growth, saying “based on the information we have at the moment we do not see a recession in the euro area”. The rate cut follows similar sized moves in July and five weeks ago. The ECB gave little in the way of guidance of the future path of rates, reiterating the “data-dependent and meeting-by-meeting approach” to setting policy.
We have seen the oil price retreating further this week as market concerns over the Middle East continue to ease in the absence of Israeli retaliation for the Iranian ballistic missile attacks earlier this month. While the Israeli government has promised a response, reports that Israeli Prime Minister Netanyahu had agreed to limit any retaliation to military targets rather than oil infrastructure or nuclear installations saw the oil price fall further. At just under $74/barrel, the oil price is around 9% below the average level of the past 12 months. Yesterday we learned that Israel had killed Hamas leader Yahya Sinwar in Gaza. Sinwar has led Hamas since 2017 and was seen as the mastermind behind the October 7, 2023 attack on Israel. Israeli PM Netanyahu said “while this is not the end of the war in Gaza, it is the beginning of the end”. Such an outcome would be most welcome from a humanitarian view, and take some uncertainty off the geopolitical agenda, though until we see how Israel responds to Iran, it is way too soon to become complacent over the ongoing risks from escalation.
