UK economics: new PM settles markets

Another new Prime Minister dials back the clock with more stability and fiscal tightening on the horizon.

Written By:

Flora Harley, Knight Frank

01 Nov 2022

3 minutes to read

Categories: Topic Economics

The new (new) Prime Minister, Rishi Sunak, has begun his tenure by calming markets. IMF chief Kristalina Georgieva added to this stating she expects Sunak to steer Britain towards fiscal sustainability.

The ‘unpredictability premium’ applied to gilts in the wake of the mini-budget (the jump in expectations) has almost been eroded – cue what has been dubbed the ‘dullness dividend’ - with the latest market rates near where they were on 21 September.

Sunak may be looking to reverse even more and move towards where markets were at the end of August. The unveiling of his fiscal plans, alongside OBR forecasts, on 17 November will add more clarity, as Georgieva said he was right to point out “these are tough times, and tough times require tough decisions.”

Strengthening pound vs dollar

The pound has clawed back some of what was lost over the tenure of the previous Prime Minister – but exchange rate movements have largely been a story of a strong dollar.

In the wake of the mini-budget the pound plummeted to $1.03. The currency has since bounced back to $1.16 most recently, but the dollar’s strength has been a driving force.

The pound is around 3% lower against the euro this year, for example, and 2.6% against the Chinese yuan - its 9% up against the Japanese yen. There could be more room to rebound if markets are amenable to the announcements on 17 November.

Rate hikes on horizon

The Bank of England (Boe) is expected to out hike the ECB and be on par with the Fed.

It is clear we will see two further rate hikes in 2022 from the BoE. The base rate will go from 2.25% currently to potentially as high as 3.75% by the end of 2022.

In reference to The Economist article, much of this has already been priced in to lending rates due to forward guidance. Rates are likely to peak in the first half of 2023, with the markets pricing just under 5%. However, a recent speech by BoE deputy governor Ben Broadbent indicated that rates may not go that high.

Short term inflation rises

Inflation will continue to rise in the short term with a less certain path from Q2 2023.

September’s headline inflation hit 10.1%, and we will see it higher in October as the cost of energy rose 27%. With the cap on energy bills from April 2023 now no longer guaranteed, the downward movements are less certain.

However, wage demands may start to alleviate with vacancies falling back, global supply chains are easing and oil prices, among other commodities, have fallen back, peeling back inflationary pressure.

These will take time to filter through but should show up in headline figures in the first half of 2023 – notwithstanding any further disruption.

Cost-of-living concerns

The cost-of-living crisis and energy security is weighing on sentiment. The prospect of rolling blackouts across Europe is garnering a lot of press.

This is especially the case in the UK after the National Grid’s Winter Outlook report. The base case is that there will be sufficient supply, however, under one scenario of reduced gas imports from Europe, households could face three hours of blackouts in January and February.

Strong labour market

Healthy labour market statistics offer respite, but also mask structural issues.

The unemployment rate has fallen to a 48 year low of 3.5% However, looking at the underlying figures and significant proportion in the drop is due to a rise in inactivity – with those long-term sick and students accounting for more than 50% of that cohort.

Despite a docket full and economic turmoil, the new government looks to be steadying the ship.

There will be doomier statistics feeding through over the winter, but the early half of 2023 we should start to see bursts of optimism. With a stronger foundation any downturn will likely be shallower than in previous cycles, notwithstanding any major geopolitical upheaval.