Well October was another remarkable month in politics with Kwasi Kwarteng and then Liz Truss both forced out of their jobs by the bond markets and their traders.
Let me explain. We hear alot about stock markets, with the likes of the FTSE 100 and the Dow Jones often mentioned in news broadcasts, but we never hear about the bond markets and yet collectively these are worth several times that of global stock-markets.
For the past decade, global interest rates have remained pretty low by historical standards and therefore the bond market has been in quiet slumber. However, this year’s global turbulence caused by the rise of inflation due initially but not exclusively to rising energy and petrol prices, shortage of goods, rising wages, shipping costs and, of course, the continued cost of covid, was then exasperated by Russia’s invasion of Ukraine which has had a huge impact on food prices, whilst heaping further pressure on energy costs and all of this has stirred the bond markets.
This turbulence has also forced central banks into making difficult fiscal decisions, which weren’t perhaps helped by their previous view of inflation this time last year when they still considered it to be transitory.
At a time when our central bank, like all others, are trying to contain inflation, some of the policies that our then new Prime Minister and her Chancellor were embarking on were highly inflationary, including the big tax cuts announced in the mini budget, although without any of the substance of how these were going to be paid for.
This not only raised eyebrows around the world, including the International Monetary Fund (IMF), it also stirred the bond market and in particular the bond vigilantes and these guys and girls are all powerful and can essentially derail the policies of a central bank or, in this case, a government if it doesn’t agree with them, and this we saw all too clearly.
The bond vigilantes, who are bond traders, didn’t agree with these unfunded policies and not only threatened to, but did sell large amounts of UK bonds in protest. This pushback against the government stopped it dead in its tracks.
I’ve mentioned in previous newsletters that the global bond market has been particularly volatile this year and because prices and interest rates work inversely, a sell-off reduces the bond’s price but at the same time increasing the cost of borrowing to the issuer.
So the Truss/Kwarteng policies not only increased the amount our government was going to have to pay for its borrowing, it also had far-reaching consequences to the trustees of gold plated final salary pension schemes because they hold government bonds to help cover some of the pension income payments.
I’ve always been mindful in these newsletters not to be seen to pass personal opinion and the following comments are not meant as anything other than reporting what we all saw, which was the resulting chaos which caused our currency to plummet against the dollar, with the Bank of England having to step in with the potential of issuing up to £ 65 billion of government bonds to protect our economy. They only used a fraction of this in the end because of the changes in the make-up of the government.
So three weeks after Mr Kwarteng’s mini budget, the new man in charge, Jeremy Hunt, was shredding his predecessors plans thereby making the positions of the former Chancellor and his boss untenable. The arrival of Mr Hunt at number 11, followed by Mr Sunak in number 10, has eased global bond and currency market tensions with the pound also recovering from its lowest level in a generation against the US dollar.
Onto other news and whilst I appreciate that the Bank of England’s announcement last week would normally be news for my next newsletter, it did increase interest rates by the expected 0.75 % this time, taking the bank base rate to 3.0 %. Whilst this is the single highest rate increase in the UK for over 30 years, it matches the 0.75 % rises made in the past few days by both the US Fed and the European Central Bank, with interest rates for the former now sitting between 3.75 % and 4.0 % and 1.75 %, for the ECB, although it wasn’t that long ago that these rates were in negative territory.
Continuing with the October look back, the UK unemployment rate fell to 3.5 % between June and August, according to the Office of National Statistics (ONS), its the lowest rate since 1974. This is being driven by a record number of people leaving the jobs market completely. Their report went on to say that the number of people classified as ‘inactive’ (neither in work nor looking for work) rose by 252,000 in the three months to August, this being the biggest such increase since records began in 1971. I think it is now common knowledge that there are more job vacancies than there are unemployed people (actively looking for work) and not just in the UK.
UK wages, unsurprisingly, continued to lag inflation over the summer according to the ONS, leaving workers with pay cuts in real terms, even though regular pay (excluding bonuses) rose by 5.4 % a year in June to August, the strongest growth in regular pay seen outside of the covid pandemic.
The inflation rate in the UK went back to 10.1 % in September, following a slight dip to 9.9 % in August, as food and drink price inflation hit its highest level since April 1980, with food and non-alcoholic beverage prices rising 14.5 % in the year to September, up from 13.1 % in August.
Inflation globally wasn’t really helped by OPEC agreeing to cut its output by 2 million barrels a day, as it seeks to halt the slide in oil prices caused by the weakening global economy. There are around 87 million barrels of oil produced every day, so as a percentage you wouldn’t think 2 million barrels would have a big impact on the oil price and so far, it hasn’t as it continues to drift down, albeit marginally.
US inflation now stands at 8.4 %, whilst Eurozone inflation hit 10.7 % in October, recording its highest ever level. Not too dissimilar to ourselves, Eurostat, the bloc’s official statistical information agency, noted that the price of food, alcohol, and tobacco had increased 13.1 % year-on-year, though the standout statistic was energy prices, which Eurostat estimated were 41.9 % higher than 12 months ago.
On mortgages, Moneyfacts (www.moneyfacts.co.uk) said that the average two-year fixed rate mortgage had risen to 6.43 %, its highest level since August 2008 (which incidentally was just before the collapse of Lehman Bros, signalling the financial crisis). The average five-year fixed rate has increased to 6.29 %, its highest level since November 2008.
Just by way of comparison, in the US, data from the Mortgage Bankers Association shows the average rate on a 30 year fixed rate mortgage now stands at 7.16 %. It seems everything is bigger in the US, including their mortgage terms, however their five-year rate at 6.95 % is more expensive than ours. I did look for comparative information from the Eurozone, but couldn’t find anything current.
More statistics from the ONS reported UK average house prices had increased by 13.6 % over the year to August, down from 16 % in July. The average UK house price stood at £ 296,000 in August, £ 36,000 higher than this time last year.
The number of homebuying transactions fell 32 % in September year-on-year according to HM Revenue and Customs and it cautioned that the recent sharp rises in mortgage rates which had followed the ‘mini-budget’ had not yet fed through to these figures – though some of the heat will be clearly off since that mini-budget was torn up.
UK business activity contracted for the third month in a row in October, reaching its slowest level since January 2021, this according to the S&P Global / CIPS UK composite Purchasing Managers Index (PMI). This gave a reading of 47.2 compared to 49.1 in September. You will recall from my previous newsletters, a reading below 50 signals contraction, whilst anything above 50 indicates growth. Regrettably, both the service and manufacturing sectors are in contraction territory. There have been times of late when the service sector has remained in growth.
British manufacturing confidence dropped at its fastest pace since the first covid lockdown, according to the CBI. Their survey showed 48 % of big manufacturers are pessimistic about the economy compared to 21 % in the July survey. The last time optimism fell so low, aside from the depths of pandemic lockdowns, was during the global financial crisis of 2008-09.
Eurozone business activity fell in October at its fastest pace in two years. The composite PMI, which accounts for both the service and manufacturing sectors, fell to 47.1 in October, so like the UK is also in contraction territory.
By contrast, the US economy expanded at an annual rate of 2.6 % in the third quarter, according to data published by the Bureau of Economic Analysis, this being slightly better than analyst expectations.