Financial Update from Brewin Dolphin - 4 August 2023

August 2023

The Weekly Round-up

Friday 4 August 2023

In his latest weekly round-up, Guy Foster, our Chief Strategist, analyses the Bank of England’s interest rate hike and China’s efforts to supporteconomic growth.

The first week of August has been a downbeat one forinvested assets after a strong rally throughout 2023. Bond yields rose and equity prices fell. For the time being at least, the performance of these two asset classes remains quite positively correlated. This suggests that inflation fears may not have entirely dispersed: if investors worry about growth, they buy bonds and sell stocks; if they worry about inflation, they sell both.

There do seem to be valid concerns on both fronts. Looking at the activity indicators around the world, the manufacturing sector generally continues to show signs of a deepening decline while the pace of services expansion slows. To find the bright spots within this otherwise very consistent story, it is possible that US manufacturing may be bottoming. By contrast, it was very noticeable that the service sector in Australia slipped rapidly into decline. Against this backdrop,the Reserve Bank of Australia left interest rates on hold this week. This was something of a surprise ,but reflects some of the paradoxes facing central bankers. Australian retail sales have ground to a halt, but property prices are picking up once more.

Bank of England

Closer to home, the Bank of England raised interest rates by a quarter of a percentage point to 5.25%, which is the highest in over 15 years. Currently, another two interest rate hikes are expected before they peak in March 2024. The Bank adjusted its forecasts to reflect more optimism on growth for this year, but a little less in 2024. Its forecasting has, however, in recent years been the subject of some criticism (although most other forecasters have struggled as well). However, whether it was driven by recent forecasting difficulties or the conflicting messages coming from economic statistics, The Bank of England acknowledged the very uncertain environment it is facing.

Headlines were made this week by the steepest drop in house prices in 14 years, but in reality prices have been relatively stable over recent months. Further falls are expected as homeowners face the cost of refinancing their mortgages, but new mortgage rates have been falling recently. This partly reflects the recent surprisingly low inflation print. Long-term interest rates seemed to take heart from the Bank of England governor’s determination to get inflation under control. The credibility earned through hiking by 0.5% in June meant that markets remained comfortable with a smaller hike in August. That increase followed an upwards inflation surprise and while the Bank of England acknowledged that monetary policy acts with long lags, its nervousness over the unpredictability of inflation means it will likely continue to be very responsive to any return of upside surprises.

Inflation

While it will take several weeks before the UK reports its inflation numbers, many European countries provide advance estimates. Most were in line with expectations, but Spain’s were surprisingly strong. This is in the context of generally very low inflation numbers for Spain, which allows utilities prices to float more freely than many European states. Therefore, falling utilities prices have brought the Spanish inflation rate far lower than that of other economies. But it means that Spain will also lose that benefit as prices have since stabilised.

Oil has been rallying during July after a robust rearguard action being fought by Saudi Arabia, which has cut oil production in response to the weak demand outlook. Saudi Arabia announced it would extend its production cut of one million barrels per day into September and that it could be prepared to deepen that cut in the future.

China

Saudi Arabia has been partly forced into action by the underwhelming recovery in Chinese activity. Generally, data coming from China has continued to suggest that this sluggish trend is in place. In response, the Chinese National Development and Reform Commission released a policy document on Monday relaxing restrictions on consumption, such as car purchase limits and improving infrastructure. The State Council then called for the introduction of local policies to ensure the healthy development of China’s property markets. These measures are being viewed as policymakers seeking targeted measures to support economic growth where previously they might have employed a metaphorical bazooka.

Chinese stocks remain volatile, showing some signs of breaking out of a recent downward trend. Sentiment towards them is very weak. Historically, the reliance of China on bold real estate and infrastructure investment as a means of stimulating the economy leaves observers wondering how effective these new policy levers might be.

Japan

The Bank of Japan (BoJ) is also experimenting with a policy change this summer. The BoJ left the target level of ten-year government bonds at zero, and maintained that the reference range for those yields remains at 0.5% either side of zero. However, in acknowledging that it will not commit to intervening unless yields reach 1%, its policy risks ridicule. In practice, of course, it may intervene between that upper reference threshold and the rigidly enforced 1% cap and indeed it has done so twice in the first week, a relatively small one and a larger one. Overall, though, the Bank of Japan has materially reduced the amount it is spending on Japanese government bonds, so the policy has been successful in that regard at least.

And finally…

The week ended with the US employment report. For the second month in a row, US jobs growth has not matched estimates. This comes after a long period of jobs growth being higher than forecasts. The difference was immaterial though. Other aspects of the employment report include wage data which was stronger than had been anticipated. Wage growth remains too fast to be consistent with the Federal Reserve hitting its inflation target, which ought to be a source of concern for investors. It was a mixed report, which offered narratives to support the bulls and the bears. But the gradual downward trend in jobs growth is becoming increasingly clear.