Markets Weekly podcast - 21 November 2022

Henk Potts (HP): Hello. It’s Monday, 21st November and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets. 

My name is Henk Potts, Market Strategist with Barclays Private Bank. Each week, I’ll be joined by guests to discuss both risks and opportunities for investors. 

Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. We’ll then discuss the broader ramifications of the UK’s Autumn Statement. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead. 

Equity markets consolidated last week as hopes that the global interest rate-hiking cycle would come to an imminent conclusion were dashed by multi-decade high UK inflation, record eurozone price pressures, and resilient US consumer spending.

Central bankers spent much of last week reiterating their resolve to tame inflation, despite the damage to growth prospects, so any talk of an easing pivot still remains premature.

In terms of equity market performance, the S&P 500 fell seven-tenths of 1% while the STOXX 600, in Europe, was essentially flat. 

In the UK, the government set about addressing the deficit in the public finances, repairing its economic reputation and providing a future platform for growth. Cognisant of the pressure already being exerted on households and businesses, the Chancellor sought to backload many of the spending measures, but there was no getting away from the size of the consolidation and the large increase in borrowing. 

The £55-billion package of tax hikes and spending cuts included an extension of windfall taxes on gas and oil companies, a freezing of tax thresholds, and the highest rate of tax, 45%, will now be levied on earnings above £125,000. Investors were also hit as the allowance for capital gains and dividends were slashed. Meanwhile, public spending, as we know, will be constrained in future years. 

Why was it necessary? Well, to fix the hole created by the mini budget and the deteriorating growth prospects for the UK economy. The measures are also a consequence of higher energy prices and rampant inflation, and to account for the increase in servicing debt due to higher interest rates.

Support for households and the vulnerable was there, including an extension of the energy price guarantee policy, although it will become less generous after April. 

The latest economic forecast from the Office for Budget Responsibility certainly made some gloomy reading. They said the UK economy is already in recession and that will last just over a year, with a peak to trough decline in GDP of somewhere around about 2% and not returning to its pre-pandemic level until the end of 2024. Unemployment, they said, would rise from 3.5% to 4.9% in the third quarter of 2024. It sees inflation falling only marginally to 9.1% this year, 7.4% during the course of 2023.

In terms of the policy impact, well, at 37.1%, the tax burden as a proportion of the national income rises to its highest level since the second world war, compared to 33.1% at the start of this Parliament. The national debt will rise from 84.3% of GDP last year to 97.6% in 2026/27. That’s a 63-year high, before declining in the final two years of the forecast. 

The Office for Budget Responsibility expects real wages to fall 7% over the course of the next two years. That would be the biggest drop on record and wipe out eight years of growth.

Market reaction was somewhat muted, it has to be said, but the increase in medium- term borrowing pushed 10-year gilt yields higher, although it was still around 1.5 percentage points lower than in the aftermath of the mini budget, while sterling fell by around about 1% against the US dollar.

On the data side, inflation prints in the UK and Europe reminded policymakers of the scale of the price pressures that are likely to be exerted. UK inflation surged to a 41-year high of 11.1%. That was versus a consensus of 9.8%. The print, in fact, was five times above the Bank of England’s target and ahead of its peak forecast of only a couple of months ago.

Whilst October’s final eurozone inflation reading was slightly lower than the previous reported measure, the revised 10.6% print still constituted a record rate. All major components contributed, with food, alcohol and tobacco, and energy taking the lead. Eurozone inflation looks set to stay in double digits through the course of this year and at the start of 2023, then start to moderate, helped by government intervention in energy markets, though we still expect eurozone price pressures to remain elevated through the course of next year, averaging 5.7%. 

The data out of China continues to disappoint, as rigorous enforcement of COVID restrictions, the collapse in the property market, and weaker external demand weighed on growth prospects. In October, domestic demand wilted as COVID cases rose and local governments tightened rules. In fact, retail sales contracted for the first time since May.

The Chinese property market has struggled with previous measures to cool the sector, the fallout from the debt scandal of property developers, and the movement to boycott mortgage payments. Property investment was down 16% year to date in October. The contraction in home sales deepened to 23%. In fact, if you look at Chinese house prices, they’ve contracted for 13 consecutive months. And, when we look at leading indicators, things such as land purchases and housing starts, well they’re down more than 40% year on year. 

We expect demand for housing will continue to remain constrained by weakened home buyer sentiment, rising job uncertainty, and elevated levels of household leverage. Meanwhile, industrial production growth moderated to 5% in October. That was down from 6.3% in September. Fixed asset and infrastructure investment remain positive, but it has also been trending lower.

In terms of the outlook, well, in recent days, actually, Chinese officials have announced tentative plans to ease travel restrictions, although the recent surge in cases around Beijing may postpone progress and a comprehensive plan to shore up the property market, including reduced mortgage rates for first-time buyers in eligible cities, tax breaks for people looking to upgrade their homes, and a relaxation of homebuying restrictions in non-tier-one cities. 

I think, whilst we can expect some further support over the course of next year, we do anticipate that policymakers will, by and large, maintain the ‘no big stimulus’ view. Given their concerns about leverage levels, they don’t want to weaken the currency further, and they don’t want to encourage inflation in China either.

As we said during the course of our 2023 Outlook presentation, without a material pivot from its zero-COVID containment policy, China’s recovery is expected to remain inhibited through the course of next year, although we will expect some improvement from the depressed 3.3% growth rate this year, to around 3.8% in 2023.

In the US, there was further evidence of the resilience of the consumer, as retail sales posted their largest increase in eight months, in October. The value of retail purchases increased by 1.3% last month. That was after flatlining in September, although we should recognise, of course, these figures aren’t adjusted for inflation.

Robust labour markets, rising wages, excess consumer savings, and the lower savings rates have been helping to cushion demand despite the deteriorating economic outlook. 

However, given the clear stress that we see on things like purchasing power, lower levels of consumer confidence, and the forecasted moderate increase in unemployment during the course of next year, we would expect private consumption growth to materially weaken over the course of 2023. In fact, for next year we expect private consumption growth at just four-tenths of 1%, much less than that 3.5% increase that we expect during the course of this year, which we think, inevitably, will, indeed, weigh on growth prospects.

So that was the global economy and financial markets last week. In order to put the UK’s budget into some perspective, I’m pleased to be joined by Olivia Gleeson. She’s Vice President of Government Relations and Policy with Barclays UK.

Olivia, great to have you on the call with us once again today. Let’s start off with your sense of how the Autumn Statement has played out politically.

Olivia Gleeson (OG): Sure. Thanks for having me. I’m not sure I can follow that whirlwind, but, yeah, I mean it feels a bit like a world away from the sort of Osborne rabbit-out-of-the-hat budgets of old, or the tax-cutting bonanza we only saw, I think it was, about two months ago now. Instead, I think you touched on it in the face of, you know, spiralling inflation and a pretty gloomy economic picture.

Our Chancellor has very little flexibility on public finances and I think that really showed. We saw tax rises across the piece, the majority of them stealth, in addition to the announcement of a pretty painful cut to public spending. And, I think, you know, The Sun described it pretty accurately over the weekend, saying it delivered very foul medicine indeed. 

But I think one thing that you touched on that we should draw out in particular, is the approach to that fiscal tightening is quite interesting. The Chancellor actually backloaded a lot of the pain, so to speak. So, he implemented some of the tax rises now, but he postponed the vast bulk of spending cuts until after the next Parliament, so that means after April 2025, which, incidentally, will be following the next General Election. 

And, of course, you know, there’s a gamble in all of this that either the economic forecast will improve so drastically over the next few years, in which case those spending cuts won’t be needed, or the government’s prudence now will be rewarded.

I think the challenge, either way, is, you know, how will voters feel about this dramatic decrease in their purchasing power at the moment, the decline in living standards endured during this government, even if those most severe cuts aren’t here yet? So, a very, very difficult package indeed.

HP: Olivia, as you said, there was a lot to digest from the statement, but if you had to choose the most politically contentious measure, which one would it be?

OG: Yeah, it’s a great question. Look, I think you touched on it. The obvious one is sort of, I mean, and ministers have just raised taxes, I think to the highest level since World War Two, and, of course, that will leave a lot of Tory MPs and their constituents disgruntled, and we’ll see debate on the Autumn Statement kicking off this week, which will be a pretty interesting litmus test of just how far that discontent has spread. 

But, looking at it from a slightly different angle, if you’ll allow me, I’d say the triple lock actually, deciding to maintain that is pretty intriguing. Now, arguably, that’s pretty good politics if you think about the Conservatives’ natural voter base, which tends to be older. But, if you think about those other age groups who are already feeling the squeeze, I think there’s lots of discussion about the squeezed middle class at the moment, and working professionals, they might be looking at that wondering just how fair that burden is. So that’s probably the one I’d call out.

HP: So, let’s look forward a little bit. You mentioned that a number of the measures will fall after the next Parliament. How do you think this budget plays into the next General Election?

OG: Yeah, I think it’s really important we think about this, not least because, you know, I just outlined that the Chancellor has made those most severe aspects for fiscal tightening a problem largely for the next government. But, I think, you know, where this leaves Labour is particularly interesting.

Now, look, they’re sitting I think on average on a 20-point lead in the polls, but this statement actually leaves them in a pretty tight spot. For one, you know, a lot of the tax rises almost stole Labour’s march. I think you mentioned, you know, the top-rate of tax, 45p, being applied more broadly and the windfall tax in the energy sector, both Labour-friendly measures.

But, more fundamentally I think, you know, if Labour were to win the next General Election, they’ll be beholden to a lot of those painful spending cuts, which are planned for after April 2025, if they want to get the deficit down. You know, to put it simply, an incoming Labour government just won’t be able to do everything that it wants. 

And then, I think, more broadly, you know, Labour or the Conservatives, it’s going to be exceptionally hard for either of those parties to run on a ticket that avoids spending cuts as we head into the next General Election. So, I think it’ll be a really interesting sort of 18 months.

HP: Well, thank you, Olivia, for your thoughts today. The stormy outlook for the UK economy will certainly test policymakers’ skills to balance fiscal responsibility and that growth agenda during the course of this economic downturn.

Let’s move on to focus on the week ahead. In the US, investors will review the latest Fed minutes over their Thanksgiving dinner, and we’ll look for any evidence that the central bank will indeed step down to a 50-basis point increase at the December meeting. Comments about the speed of inflation moderation and the softening of labour markets will be eagerly awaited.

Wednesday’s US October advance durable goods report will be more informative than usual to provide signals about whether manufacturing and equipment investment are set to join housing as weak spots in the resilient overall US demand picture, though we expect the volatile non-defence aircraft category to drive a 1.2% month-on-month increase in the headline rate, after taking on last month’s solid new orders report coming through from Boeing.

In Sweden, we expect the Riksbank to raise rates by 75 basis point, to 2.5%, at this week’s meeting. The bank’s rate-path forecast is likely to show a terminal-rate cap of around 3%. We expect the bank to hike by 50 basis points in February next year and conclude the hiking cycle with rates at, indeed, 3%. 

Its inflation forecast is likely to be adjusted higher in the near term, but lower towards the end of the forecast horizon. Its growth forecast is likely to be adjusted down, showing a deeper recession during the course of 2023 than was previously projected.

With that, we’d like to thank you once again for joining us. I hope that you found this update interesting. We will, of course, be back next week with our latest instalment, but for now may I wish you every success in the trading week ahead.

(end of recording)