JP’s Journal: Whack-a-Mole

UK Economy

While relatively very few of us will have known or have met her, Queen Elizabeth’s passing and the dawning of the Carolean era is momentous.


It is said that he is his own man with his own agenda but, having waited longer than any other royal heir before taking their place on the throne and despite it being unlikely that he will play any more of an active role in politics than his mother, King Charles has big (or at least very sensible) shoes to fill.


Having been completely contained within the national period of mourning, last week was suitably relatively subdued as far as UK bond markets were concerned. The previous week’s victory by Liz Truss in the race to become the new leader of her party and, thus, the new UK Prime Minister, seemed long forgotten. And it was perhaps fortunate for the Prime Minister and her new cabinet, in their first week in office, that the Bank of England’s (BoE) keenly awaited and fairly crucial September policy rate decision was postponed to this week; that might give everyone more time for contemplation of the most recent economic data before not only the postponed policy rate announcement but also the ‘mini budget’.

Market trends unchanged

However, the sombre mood in the UK did not stop global currency markets showing what they thought of the most recent data against current and expected interest rate policy. These showed headline inflation falling slightly in August, mainly as a result of lower petrol prices. However, core inflation excluding food and energy (but, notably to a dog owner, including dog food, which is classed as a pet supply!) rose and GDP growth was lower than expected and only slightly positive in July. BoE rate hike expectations were evenly split between 50bps and 75bps, from a starting level of 1.75%, although this is already 75bps lower than the US Federal Reserve (The Fed) policy rate and could be as much as 175bps lower if the Fed were to go ahead with a potential ‘super hike’ to 3.50% early this week. The result was a fall in sterling to its lowest rate versus the US dollar since 1985.


So how did bonds fare last week? Yields on 10-year UK gilts moved up by another 4bps, further beyond 3%. Rises were, for a change, more pronounced in other markets but the direction was the same. Implied breakeven inflation rates, globally, generally moved sideways but, in the UK, the picture simply repeated the previous week’s pattern; they fell at shorter maturities, reflecting the lower expected rate as a result of energy price limitation over the next two years, but less so at longer maturities, reflecting the fact that near-term borrowing will only postpone actual inflation. Credit markets were marginally stronger, with investment grade spreads 4bps tighter and excess returns of 0.32%, whereas high yield markets were slightly weaker with 27bps of widening and excess returns of -1.02%. Expect this week’s markets to be much noisier and more volatile.


For King Charles’ first Prime Minister, this is a big week. The mini budget should contain more detail of just how the proposed ‘cap’ on energy prices will work and how much it is expected to cost. But, on the basis that core inflation is already rising and the cost of the cap, somehow and eventually (through future taxation), must be recovered, such emergency action feels familiar; push down immediate impacts so that we are not swamped by them but expect to deal with the problem for a lot longer, or at least pop up somewhere else. To paraphrase the words of a historian I heard last week, if the shoes you’re looking to fill aren’t suitable, get a new pair.


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