- Weekly update
- 5 minute read
A good week for
- Non-UK equities prospered in sterling terms, led higher by Japan (c. +2%)
- The US dollar appreciated c. +1.5% on a trade weighted basis
A bad week for
- Sterling weakened against the dollar and the yen
- Bonds continued to weaken in the UK and US
UK monetary policy
The Bank of England (BoE) raised interest rates at its May meeting, and upgraded economic forecasts. The nine members of the Bank’s Monetary Policy Committee voted seven to two in favour of a rate rise, reflecting the continued strength in the labour market and better-than-expected economic data. Economic forecasts were revised meaningfully higher than February’s report, though the already-executed tightening is expected to weigh on growth. GDP is now forecast to average +0.25% in 2023, compared with -0.5% in February, and +0.75% in 2024, compared with -0.25% in February. In 2024 and beyond, these forecasts could be revised higher, as the BoE’s forecast only reflects current fiscal policy and the Conservatives are expected to relax fiscal policy to bolster their chances at the coming election. As well as GDP, labour market estimates were revised higher, with unemployment only expected to rise to 4.5% by the middle of 2026. This in part reflects expectations that employers will hold onto workers, even as the economy slows, because of the difficulty in finding new workers. The BoE also highlighted the risk that wage growth and price inflation may fall back more slowly than anticipated, as households and firms seek to rebuild balance sheets. All in all, the Bank’s more hawkish tone makes a further hike possible, but the large revisions to the forecasts make it less likely that economic activity meaningfully surprises to the upside.
Recent volatility facing US banks is expected to weigh on credit conditions, leading to slower growth. The US Federal Reserve’s latest Senior Loan Officer Survey, which asks bankers about credit conditions, showed further tightening and weaker loan demand. Lending conditions have been tightening since the middle of last year, reflecting rising interest rates, and now are at levels previously only seen during recessions. Business sentiment also suggests that businesses are facing tighter credit conditions and weaker investment intentions.
Against a backdrop of tighter credit conditions, April’s inflation report painted a mixed picture for the US Federal Reserve. Headline inflation slowed on a year-on-year basis to 4.9% from 5% in March, but month-on-month inflation actually accelerated to 0.4% from 0.1%. This was mostly down to stronger used car prices, which pushed up goods inflation. Within the basket, headline core inflation slowed to 5.5% year-on-year, from 5.6%. Digging down further still, “super-core” inflation, which strips out not just energy and food, but other somewhat volatile components, slowed to 0.11% month-on-month, the lowest level since last summer. However, “super-core” services inflation, which strips out shelter, health insurance and air fares, accelerated to 0.49%. Given that this component perhaps best reflects wage growth pressure, the Fed may interpret its continued strength as a cause for concern. Nonetheless, weaker credit growth and already-executed tightening are expected to cause US growth to slow in coming quarters, releasing pressure on the Fed.
US debt ceiling
Once again, the US government faces defaulting on its debt as the limit on the debt ceiling nears. By law, the US government must agree on a limit to borrowing, and the Treasury are able to extend spending by a few months by employing workarounds. Treasury Secretary Janet Yellen, has suggested that the Treasury will have exhausted these measures by 1 June, which risks a partial shutdown of some government services, in order to continue to make interest payments on US debt. The debt ceiling is a frequently occurring problem, and the US has not yet breached is covenants on its debt, though brinkmanship and market volatility are common. The most likely outcome of a debt ceiling resolution is a cut to fiscal spending, with the Republicans seeking cuts to the Democrats’ proposed fiscal plans.
Chinese trade data pointed to weaker goods demand in April. Chinese exports grew by 8.5% on a year-on-year basis, down from 14.8% in March. Imports also slowed, falling by -7.9% versus -1.4% in March. This underlines the fact that weaker global demand, from weak growth and goods destocking, may be a headwind for growth in 2023.
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