24 October 2022: Ex-chancellor in the driving seat

Ex-chancellor in the driving seat

24th October: Highlights

  • Truss’s legacy will be years of higher mortgage rates
  • Q3 GDP data due for release
  • Inflation close to peak according to the ECB

GBP – Sunak only candidate with the 100 required supporters

The battle to become leader of the Conservative Party should become clearer this week. Although, even if a leader is elected, there is no guarantee that they will command the full support of the parliamentary party.

Anyone considered for election must have the support of at least 100 MPs by 14:00 today. Only former Chancellor of the Exchequer Rishi Sunak has reached that level.

Former Prime Minister Boris Johnson has decided not to run, saying that he had the numbers, but it’s not the time to split the party.

While the country is gripped by political confusion, the Bank of England is preparing to decide whether to hike interest rates and by how much.

The extended period of tightening is expected to continue. However, the Monetary Policy Committee still needs to decide whether the hike will be fifty or seventy-five basis points, given that headline inflation is now above 10%.

Prime Minister Liz Truss will leave office Friday as the shortest-serving Prime Minister. A period of introspection will likely result should either Sunak or Penny Mordaunt be chosen. It will be tough for Mordaunt to gather the necessary 100 votes to continue, so the vote may simply turn into a coronation for Sunak.

The UK economy continues to suffer. Despite the mayhem caused by the recent mini-budget having calmed down, mortgage borrowers will still be paying more than they have over the last few years. That will be Truss’s legacy.

Data for services output will be released today. Output will likely have fallen into contraction, dropping to 49 from 5.

Truss’s resignation did not particularly phase the Pound. Sterling rose from a low of 1.1060 to close at 1.1315 last week, as traders got to grips with the news that the UK would have its third Prime Minister in a little over six weeks.

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USD – Fed poised to hike again next week

The FOMC will meet next week to decide on another interest rate hike. A seventy-five-basis point hike in the federal funds rate is the Central Bank’s most likely course of action.

However, some believe that a one-hundred-point hike would send the correct message about how serious the Fed is about fighting inflation.

Prices continue to rise despite rate hikes taking place at every meeting.

More dovish members of the FOMC believe there is a growing danger that continuing hikes will push the economy into recession, as interest rates have reached the point where they restrict growth.

Powell has been accused of becoming obsessed with cutting inflation to the Central Bank’s mandate of 2%.

Many observers believe he is chasing an impossible dream, as major factors behind rising inflation are beyond his control, and that he risks a recession continuing with his obsession.

The number of new jobs created by an economy is a litmus test for an economic slowdown. Several banks have predicted the economy will begin to shed jobs in the first quarter of next year, with the number reaching close to half a million by March 2023.

While the rate of job growth has slowed over the past few months, there is no sign that it will slow to such an extent as to turn negative.

It is more common for job growth to remain low, rather than turn negative when the economy slows. However, several figures indicate that negative growth may be possible, including the rate at which interest rates have risen.

The Fed meeting takes place next Wednesday. It’s likely they have had access to October employment data, which is only due for release next Friday.

The Dollar Index had a mixed week due to several factors. It is struggling to regain the 114 level. It reached a high of 113.75 but lost traction and fell back to close a fraction lower on the week at 111.90.

EUR – ECB meets this week with another hike expected

The Governing Council of the European Central Bank is gathering in Frankfort to determine the level of short-term interest rates in the Eurozone.

It is almost certain that a rate hike will be agreed upon, as rising inflation shows no sign of abating.

However, as the Eurozone will likely fall into recession early in 2023, if it hasn’t already, the Central Bank will need to tread carefully if it is not to worsen an already precarious situation.

Christine Lagarde and her chief economist have commented over recent weeks that the ECB is committed to a continued programme of rate hikes, but have otherwise been a little ambiguous.

Lagarde believes that rate hikes will continue for the next several meetings. Philip Lane believes the Governing Council is being deliberately vague about the number and size of rate rises over that indefinite period.

The Bundesbank and its supporters in the hawkish camp will likely try to persuade the council that a one-hundred-point rate is necessary. Meanwhile, the doves, due to their belief in the need for support, not higher rates, will likely try to achieve the bare minimum of fifty.

This meeting will likely make history since it will be the first time any Central Bank has hiked rates when its economy is so close to a recession.

This week’s data is expected to show that output fell even further into contraction. The composite PMI is expected to have fallen to 47.5 from 48.1 last month. Tomorrow’s IFO survey for Germany may also make for difficult reading.

The Euro looks like it may drop to the 0.96 level, but a lot depends on how hawkish statements from the ECB press confidence are. Last week, it managed to climb to a high of 0.9875 and closed at 0.9862.

Have a great day!

Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.