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As we kick into the notoriously quiet summer holiday season, I must admit it has been anything but quiet recently, both in financial markets and in the Theodosiou household.
In markets, when I last wrote, the world was expecting two 50 basis point rate increases across the pond. Instead, we saw two consecutive 75 basis point interest rate hikes in the US. This helped power the greenback to multi-year highs against many currencies, as the dollar continued its 2022 strength.
In markets, when I last wrote, the world was expecting two 50 basis point rate increases across the pond. Instead, we saw two consecutive 75 basis point interest rate hikes in the US.
In Europe, the European Central Bank raised interest rates by 50 basis points to move out of negative territory for the first time in eight years. However, this didn’t stop the single currency trading below parity against the dollar in July for the first time in almost 20 years.
In the UK, the pound traded up to 1.22 against the dollar in advance of Thursday’s Bank of England meeting, after reaching a low in the 1.17s last month. The Monetary Policy Committee hiked rates an unusually large 50 basis points, the largest since the Bank of England became independent, showing that ‘50 is the new 25’ when it comes to rate changes in this high inflation environment.
At home, we got through ‘birthday season’, with both my boys having their birthdays in July and the accompanying parties that followed. My eldest had an outdoor party involving bushcraft and a game of laser tag in the forest. The highlight was a game of capture the noodle (think capture the flag but with a swimming noodle), with kids running back and forth trying to get both noodles in their base camp to win the game.
One girl came racing down the left side, weaving through trees and yelling: “I’ve got it, I’ve got it!” But just before she reached her base, on the right side a boy was sprinting in the opposite direction with the other noodle yelling the same thing. We had a few collisions and injuries from tired kids and inconveniently placed trees. My son’s team lost on the day but, in the end, fun was had by all.
Meanwhile, my youngest enjoyed a science party at the local village hall, culminating in a small rocket being launched by the entertainer. It shot off into the air, before catching the wind and drifting off into a neighbouring field – never to be seen again.
Central banks continue to play their own variant of capture the noodle it seems, running down the left side clutching tighter monetary policy in the form of historically aggressive rate hikes and quantitative tightening, while down the right side run inflationary forces such as the ongoing Ukraine conflict, high energy prices, and a tight labour market – stopping them from winning the game. Round and round they go, until the point where everyone gets tired and runs into a metaphorical tree.
Forward looking economic indicators, such as Purchasing Manager Index data and confidence surveys, are pointing to the risk of economies hitting an obstacle, as tighter central bank policy hits consumer and business confidence. In turn, this should dampen demand – as is the plan of central banks with their fast policy tightening – and while this may help bring inflation down, it also risks a recession.
The US printed two consecutive quarters of contraction recently, entering what some would consider a technical recession, yet the rhetoric continues to be around further policy tightening. Markets are already pricing in interest rate cuts next year, however, as the Fed may need to reverse the explosive action of recent months. With this, the dollar has come off its highs and now seems to have put a short-term top in place against many pairs, as US bets are scaled back with a perceived deterioration of the forward-looking economic outlook.
In the UK, the Bank of England continued its steady interest rate hike cycle, this time by 50 basis points, and coupled the inflation fighting policy move with projections of a December recession that could last over a year.
In the UK, the Bank of England continued its steady interest rate hike cycle, this time by 50 basis points, and coupled the inflation fighting policy move with projections of a December recession that could last over a year. Such times we live in, where recessions are predicted in the same breath as once-in-a-generation rate increases!
In advance of the meeting, the pound strengthened to just shy of 1.20 against the euro, as Europe continues to suffer in the shadow of an uncertain winter commodity supply ahead, with Russian production continuing to tail off. Soon after, however, sterling retraced on the bearish UK GDP outlook.
Looking ahead, there is an added dynamic to throw into the mix domestically – a Conservative party leadership campaign to appoint the next prime minister. The bookmakers’ favourite at the time of writing, Liz Truss, has promised around £30 billion of tax cuts within weeks of taking office, paid partly by more borrowing. Her rival, ex-Chancellor Rishi Sunak, has shown concern this would only stoke the inflation fire and jumped on some economist projections of interest rates jumping to 5-7% under this scenario.
In fact, some bank analysts are expecting a fall in the pound of up to 2% should Truss be successful in her campaign, due to her economic policies. Tax cuts of £30 billion would certainly be a huge rocket launch for the UK consumer, but one has to hope it doesn’t catch on the winds of inflation and end up drifting economic activity where nobody wants it to go.