UK Autumn Statement Restores Confidence in Sterling

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Eurozone Market Update

In November, the focus was on the European Central Bank’s (ECB’s) targeted longer-term refinancing operation (TLTRO) repayment. The first TLTRO III repayment saw an aggregate of €296.38 billion (of €2.1 trillion outstanding). This represented approximately 15% of the total outstanding amount and was below market expectations, possibly due to the short time between the ECB’s announcement and the repayment date. December’s repayment data will be a better gauge of the appetite for banks to repay the loans early. ECB President Christine Lagarde indicated the risk of recession in the eurozone has increased, but a mild recession is unlikely to quell inflation significantly. Indeed, inflation is likely to remain high for an extended period. Annual eurozone inflation did fall from 10.7% in October to 10% in November, but still has a long way to go to reach the ECB’s target.

UK Market Update

The Bank of England (BoE) raised interest rates by 75 basis points (bps), taking the bank rate to 3%. Despite this, Governor Andrew Bailey and Chief Economist Huw Pill suggested the future rate path would be less pronounced than market expectations. UK annual inflation hit a 41-year high of 11.1% in October, but core inflation held steady at 6.5% from September. In the Autumn Statement to the House of Commons, Chancellor Jeremy Hunt unveiled a £55 billion multi-year fiscal tightening budget funded by £30 billion in spending cuts and £25 billion of tax rises, boosting the pound and gilt markets. Throughout the month, the implied interest rates in the UK by the end of the year rose from 3.59% to 4.38% (see Chart of the Month).

US Market Update

As widely anticipated, the Federal Reserve unanimously voted to raise interest rates by 75 bps, taking the repo and reverse repo rate to 3.80% and interest on reserve balances rate to 3.90%, respectively. The Federal Open Market Committee (FOMC) asserted they will focus on “the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments” when it comes to future rate hikes. We take this as a clear sign the Fed is now preparing to reduce the size of their rate hikes at upcoming meetings, with a shift to 50 bps at the December meeting as a starting point, which is now supported by the market.

Looking Ahead

Incoming inflation and labour data will prove pivotal for the upcoming FOMC, BoE and ECB policy decisions on 14 and 15 December. The market’s focus has recently shifted from the endpoint to the pace of monetary policy tightening, with some confusing a slowdown in the pace of hikes with a dovish pivot. Central bankers remain focused on taming inflationary pressures at upcoming meetings. However, they are now recognising the risks of overtightening and its negative impact on the economy. Market participants should pay particular attention to this balancing act. This is why we expect all three central banks to end the round of ‘jumbo’ hikes in December and shift to 50 bps hikes, unless we see any shocks in the data.

Chart of the Month: Don't Call it a Pivot! Hikes to Soften but Continue

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