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Weekly Focus – UK Political Turmoil Continues

UK Prime Minister Liz Truss stepped down this week after only 44 days in the office. The resignation follows heavy pushback on the ‘mini-budget’ presented in late September, which sparked fears of even more persistent inflation and much stronger rate hikes by the Bank of England. The new chancellor Jeremy Hunt has already overturned many of the spending measures introduced in the mini-budget, which has supported GBP and eased the pricing on BoE hikes. Going forward, the conservative party aims to find a new PM already next week, and the process begins by conservative MPs voting to select two final candidates on Monday. Then, the party members will cast the final deciding vote by Friday October 28 at the latest, or alternatively the less popular of two withdraws without a vote by the party members. At the time of writing, former chancellor Rishi Sunak is the most likely candidate followed by the former Prime Minister Boris Johnson.

The European Council agreed on joint measures to limit energy prices largely in line with the earlier proposal by the Commission. While details still remain uncertain, the measures include ‘a dynamic price corridor’ to limit further rises in gas prices despite the earlier pushback by Germany. In addition, EU will work to set up a mechanism to cap the price of gas used for electricity generation, to create a new benchmark for gas prices and to create a voluntary joint purchasing platform (see details here). Spot gas prices have eased to the lowest levels since the start of the war as inventory levels are now close to full in most EU countries, but long-term solutions to replacing Russian gas still remain uncertain.

Market sentiment has remained cautious not least on the back of the UK political uncertainty. US 10y bond yields have reached new cycle highs above 4.20%, but in contrast to the rise seen earlier this year, the most recent uptick has been driven largely by higher inflation expectations – a worrying development for the Fed in light of the persistent upside surprises in realized inflation. FOMC silent period begins on Saturday, this week’s communication has supported our call for 2x75bp hikes in the last two meetings of the year.

Next week, we expect the ECB to hike its policy rates by 75bp. The move is fully priced in by the markets, so focus will be on communication. We expect Lagarde to acknowledge that the risk of the September’s downside scenario materializing has increased (-0.9% growth in 2023). In addition, markets will focus on comments about ECB potentially ending APP reinvestments next year to complement the liquidity tightening from maturing TLTROs. See our full preview: ECB Preview – Focus on the technicalities, 19 October.

In contrast, Bank of Japan embarked on emergency bond buying this week, and we see no tightening indications ahead of next week’s policy meeting. We will look out for further FX intervention to stem the yen slide, but as global yields continue to rise, so does the pressure on BoJ, which seems determined to defend its yield curve control.

On the data front, markets will focus on the October Flash PMIs on Monday. We expect further signs that euro area is sliding towards a recession already this year, while US growth remains modestly positive. On Thursday, we see upside risks to our forecast for the US Q3 Flash GDP at +1.1% q/q AR, as the recent sharp decline in imports could have boosted net exports more than anticipated.

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Danske Bank
Danske Bankhttp://www.danskebank.com/danskeresearch
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