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Tax on, tax off… tax on again

Weekly update
  • Weekly market update
  • 5 minute read

A good week for

  • Sterling rallied, gaining c. +1% against the dollar and the euro, and over +3% against the yen

A bad week for

  • Equities weakened, led lower by emerging markets, which fell over -4.5% in sterling terms
  • Bonds weakened, with gilts falling c. -2%, and US bonds falling c. -1%

UK economy

With the after-effects of the ‘mini-budget’ still being felt in markets, the UK Government took further action in an attempt to reassure investors. Having cancelled the abolition of the top rate of tax and brought forward the timing of the Autumn Budget to the end of October, Prime Minister Truss dismissed Kwasi Kwarteng as Chancellor and reinstated plans to raise corporation tax to 25%. Kwarteng was replaced by Jeremy Hunt, who outlined plans to reverse tax cuts, at the same time cutting government spending, in a bid to return UK government borrowing to a sustainable path. On Monday, it was announced that Hunt would reverse all other measures, apart from cuts to National Insurance and stamp duty. The Energy Price Guarantee will now run in its current form until April 2023, with new restrictions to be introduced thereafter. If bond yields continue to fall, this will help the Government close the fiscal gap it faces at the end of the OBR’s forecasts, but significant spending cuts are also likely necessary to do so. All in all, the direct impact of these measures is less supportive for growth. However, if the measures are able to bring down UK bond yields, it will help remove the drag on growth from tighter financial conditions.

Bank of England

Last week, the Bank of England ended its market intervention to cap bond yields. The bank, had committed to buying up to £5bn of long-dated government bonds per day, but extended the programme to include an extra £5bn of index-linked bonds, despite relatively few bonds actually being purchased. The Bank also announced a temporary expansion to the “collateral repo facility”, accepting index-linked government bonds and investment-grade corporate bonds as collateral. Ahead of the end of the programme, bond yields did rise, and purchases did increase. Now the purchase programme is over, bank staff must decide if the planned programme of bond sales should go ahead as planned at the end of October. Doing so, once again, risks sending bond yields higher.

UK Labour

As well as decisions on the balance sheet, the Bank of England must set monetary policy on 3 November. Futures markets are pricing in a significant rise in the Bank Rate, though the outlook for UK growth has arguably deteriorated, making the case for less tightening. However, August’s data, released last week, showed inflationary pressure in the tight UK labour market. Unemployment fell by 97,000 in the three months to August, sending the unemployment rate down to 3.5%. Wage growth also accelerated with and without bonuses, while headline pay rose by 6%. Moreover, participation deteriorated further, with 333,000 more workers becoming inactive, in large part due to long-term sickness. While the pace of new job vacancies fell for a fourth month in a row, and slowing growth should lead to a weaker labour market, the shrinking labour force could be a source of inflationary pressure greater than the Bank had initially expected.

US Inflation

September’s US inflation data offered little relief to markets, despite headline inflation slowing. The overall Consumer Price Index rose by +0.4% on a month-on-month basis, translating to a +8.2% year on year rise, lower than August’s 8.3% print. However, core inflation strengthened, rising by +0.6% on the month, and 6.6% on the year, compared to +6.3% in August. This was down to high housing costs, but also strength more broadly in the core basket. While the Fed will certainly welcome the continued decline in headline inflation, continued strength in core inflation will be a worry, exacerbated by last week’s strong labour market report, and still-strong wage growth. Reflecting this, the US Federal Reserve is expected to continue tightening interest rates further in order to cool the economy and the labour market.

Sinoamerican Relations

The US has issued new export controls designed to cut China’s access to advanced technology used in supercomputing. The rules ban US firms from enabling any semiconductor development or production in China and from providing technology, software, manufacturing equipment, and commodities used in integrated circuits and supercomputers without a license. The US Bureau of Industry and Security says these measures are for national security, to limit China’s access to artificial intelligence and supercomputing-enhanced weapons. Stocks of Chinese hardware firms fell, as investors fear the rules will hit manufacturing processes, while US chip makers have suffered on the news, as demand may be lower.

 

 

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