Triple Whammy

Weekly Briefs
19 Dec 2022
7 min read
Triple Whammy

Last week was dominated by macro news, with lots of important economic updates coming out of both sides of the pond (the UK and US). But by far the biggest highlight of the week was the triple whammy of interest rate hikes, with the Federal Reserve (Fed), Bank of England (BoE), and European Central Bank (ECB) all raising interest rates by 50 basis points each between Wednesday and Thursday.

Macro (UK)

New data out on Monday showed Britain’s economy rebounded in October a little more strongly than expected from the month before. On a month-on-month basis, UK GDP grew by 0.5% in October – a sharp turnaround from September’s 0.6% drop when economic output was affected by a one-off public holiday to mark the funeral of Queen Elizabeth II. What’s more, GDP in October was 0.4% higher than its pre-pandemic level in February 2020.

The UK economy bounced back from September's drop but the outlook remains bleak. Source: Bloomberg

Still, the rebound won’t be enough to prevent the UK economy from dodging a recession, with a contraction this quarter looking inevitable as a wave of December strikes amplifies a drop in activity. The BoE said last month that even without further rate hikes, the economy is set to shrink in five of the six quarters until the end of 2023. Yikes…

Strikes are planned on almost every day for the rest of December. Source: Bloomberg

Another problem the BoE is facing is UK wages rising at close to a record pace, which maintains consumer spending and keeps the pressure on inflation. Case in point: new data out on Tuesday showed average earnings (excluding bonuses) in the private sector were 6.9% higher in the three months through October than a year earlier. That’s the biggest increase since records began in 2001, barring the height of the Coronavirus pandemic. 

Public sector workers weren’t so lucky and are suffering a much bigger hit to living standards, with their earnings growing by just 2.7% over the same period. That marks one of the biggest wage growth gaps recorded between the private and public sectors, and is a major reason behind all the December strikes. The government has offered public-sector workers a 5% wage raise on average, insisting pay restraint is needed to repair its finances and bring down inflation.

UK wages are rising at close to a record pace but the gap between private- and public-sector pay growth is now at historic levels. Source: Office for National Statistics, Bloomberg

What’s more, Tuesday’s data also showed that the worsening economic outlook is starting to affect the labor market, with vacancies falling for a fifth consecutive quarter and unemployment edging up by 0.1 percentage point from the previous quarter to 3.7%. The BoE expects unemployment to rise above 6% over the next three years, but given the challenges faced by businesses in hiring in recent months, companies may choose to freeze headcount rather than make redundancies even as a recession and rising costs lower their profit margins.

Speaking of higher costs, the latest UK inflation report came out on Wednesday and was better than expected. Consumer prices in the UK were 10.7% higher in November compared to the same time last year – lower than the 10.9% economists were expecting and a marked easing from October’s 11.1%, which was a 41-year high. While inflation is still very elevated, November’s report raised the possibility that the worst of the cost-of-living squeeze is over and was welcomed by investors. What’s more, economists viewed the drop in core inflation – which excludes energy, food, alcohol, and tobacco prices – from 6.5% in October to 6.3% in November as a further positive sign that underlying price pressures were moderating.

Britain's inflation rate dripped from a 41-year high in November. Source: FT

The BoE agrees, saying on Thursday that Britain’s inflation rate may already have peaked. That same day, the BoE raised interest rates by 50 basis points to 3.5% – their highest level in 14 years. That was the central bank’s ninth increase in a row, sure, but it still warned that further rate rises were likely. After all, inflation is still five times higher than the central bank’s 2% target, even if it did peak last month.

Slowing inflation doesn't mean the end of rate increases. Source: Bloomberg

Macro (US)

Moving over to the US, the latest inflation report out on Tuesday showed consumer prices increased by 7.1% in November compared to the same time last year, and that was good news for several reasons. First, it’s the smallest annual advance this year. Second, it was lower than the 7.3% economists were expecting. And third, it was a marked slowdown from October’s 7.7%. On a month-on-month basis, consumer prices increased by a less-than-expected 0.1%. Core consumer prices, which strip out volatile energy and food components, advanced 0.2% from October (its smallest monthly advance in more than a year) and 6.0% from a year ago. Both these figures came in below economists’ forecasts.

November's inflation report offered signs that the highest price gains in decades is finally cooling. Source: CNBC

The better-than-expected report offered hope that the worst of inflation has likely passed, which would allow the Fed to decelerate its aggressive rate-hiking campaign. Speaking of which, after increasing interest rates by 75 basis points for four consecutive meetings, the Fed finally slowed down its tightening pace and hiked rates by 50 basis points instead on Wednesday.

The move, which was widely expected by investors, raised the central bank’s benchmark rate to a 4.25% to 4.5% target range. Policymakers projected rates would end next year at 5.1%, according to their median forecast, before being cut to 4.1% in 2024 – a higher level than previously indicated. Finally, Fed officials gave a clear sign that they expect higher rates to impact the economy, cutting their 2023 and 2024 growth forecasts to 0.5% and 1.6% respectively. In September, most officials predicted economic growth of 1.2% for 2023 followed by a 1.7% increase in 2024.

The Fed's latest "dot plot" projected rates would end next year at 5.1% before being cut to 4.1% in 2024. Financial markets, in contrast, expect rates to end 2023 at around 4.4%. Source: Bloomberg

Macro (EU)

The ECB also joined the rate-hiking party last week, raising borrowing costs by 50 basis points on Thursday. That takes the central bank’s key interest rate to 2% – its highest level in 14 years. What’s more, the ECB warned of further rate rises to come, saying it expects “to raise interest rates at a 50 basis-point pace for a period of time”. For reference, in its previous two rate-setting meetings, the ECB raised borrowing costs by 75 basis points each time. What’s more, the bank on Thursday lifted its inflation forecast for this year to 8.4%, 6.3% next year, and 3.4% in 2024 – the last of which is still higher than the ECB’s 2% target.

The ECB's current rate-rise cycle is its most aggressive ever. Source: FT

Finally, the ECB on Thursday also announced plans to start shrinking its €5 trillion bond portfolio that it had acquired over the past eight years. It will initially shrink the debt pile by €15 billion a month by reducing the amount of maturing bonds it replaces with new purchases from next March, before reviewing the pace of the operation in the summer.

This week

Markets are relatively quiet ahead of the Christmas holidays, but there are still a few things left on the economic calendar.

  • Monday: German Ifo survey (a closely watched business climate index that acts as an early indicator of morale in German industry)
  • Tuesday: Bank of Japan interest rate decision (markets expect the central bank to keep rates unchanged at negative 0.10%)
  • Wednesday: US existing home sales for (November) and US consumer confidence (December)
  • Thursday: Final readings for third-quarter US and UK GDP
  • Friday: Japanese inflation (November) and US new home sales (November)
  • Sunday: Christmas! Due to soaring food costs in 2022, Santa’s probably lost a few kilos, with traders expecting him to fit into most chimneys this year.
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The information and data published in this research were prepared by the market research department of Darqube Ltd. Publications and reports of our research department are provided for information purposes only. Market data and figures are indicative and Darqube Ltd does not trade any financial instrument or offer investment recommendations and decision of any type. The information and analysis contained in this report has been prepared from sources that our research department believes to be objective, transparent and robust.

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