Brooks Macdonald – Weekly Market Commentary

Please see below, this weeks Weekly Market Commentary from Brooks MacDonald received late yesterday afternoon (26/09/2022).

This weeks commentary looks at the increase in interest rates around the world in recent weeks, the fiscal event in the UK last week and at the reaction from sterling and the gilts markets.

Global interest rates rise last week as a second week of major central bank meetings conclude

Last week was dominated by monetary and fiscal developments as we saw 500bps of rate rises from global central banks and the unveiling of the UK mini-budget. Against this backdrop bond yields rose and equity markets suffered, bringing major equity indices back to around their 2022 lows.

UK Chancellor unveils the largest tax cutting budget since the 1970s

The UK’s fiscal event was revealed as the single largest tax cutting budget since 1970¹. The Chancellor has pursued an aggressive tax cutting agenda, particularly impacting higher earners, in order to pursue economic growth. Global financial markets were less keen however, reflecting that such a cut would increase the budget deficit of the UK and raise borrowing costs. There is very much a short term versus long term narrative here. In the long run, cutting taxes may boost growth and help drive internationally mobile talent towards the UK. In the short term though, the higher budget deficit will need to be financed by international investors who have not been won over by what is seen as a fiscal handout at a time of heightened inflation. With markets already highly volatile due to inflation fears, the higher certainty of short term factors have won out, leading to higher gilt yields and weaker sterling.

Friday’s fiscal announcement, and comments from the Chancellor over the weekend that more cuts are on their way, creates a credibility problem for the Bank of England. Last week the Bank opted for a smaller 50bp move instead of a 75bp² move after balancing inflation and economic growth risks. The heavy downward pressure on sterling since Friday risks further import price inflation which will worsen the cost-of-living crisis. The Bank is therefore likely to want to get on the front foot, raising interest rates by a sizeable quantity to restore faith in the independence of the Bank of England.

Sterling falls and gilt yields rise as investors react to higher government borrowing expectations
Bank of England Governor Bailey has two broad options, talk big or act now. Comments today outlining that the Bank is determined to raise interest rates aggressively in November due to rising inflation fears would be a good start although market assumptions have already baked some of this into expectations. The perhaps politically less palatable move would be an emergency rate hike today which would show that the Bank was determined to act quickly when the facts change. Such a move may look politically charged however, given such a decision would raise government borrowing costs one business day after the government had announced plans which will lead to a larger budget deficit, which the bond market will need to absorb.

¹ Bloomberg, 23 September 2022 (https://www.bloomberg.com/news/articles/2022-09-23/uk-sets-out-biggest-tax-cuts-since-1988-to-boosteconomic-growth)

² Bloomberg, 22 September 2022 https://www.bloomberg.com/news/articles/2022-09-21/bank-of-england-is-set-to-raise-base-interest-rate-andstart-qt-asset-sales