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Bank of England warns on inflation and growth

Last Week in the City provides a round-up of market movements and the global investing outlook. This covers the week to 5 August 2022.

| 13 min read

US stock markets continued July’s rally in the first week of August, buoyed by a generally good reporting season and some positive economic data from the services sector, which showed surprising strength. Gains occurred despite hawkish rhetoric from the Federal Reserve and a further deterioration of relations between Washington and Beijing following House Speaker Nancy Pelosi’s visit to Taiwan.

In the UK, the Bank of England gave a downbeat assessment of the UK’s economic prospects as it raised interest rates by the largest amount since it was granted operational independence by Tony Blair’s government in 1997. The UK central bank now expects inflation to hit 13% in the fourth quarter of the year, with the UK expected to enter a lengthy recession at about the same time.

Earnings reporting season continues, with second-quarter figures from companies operating in many sectors beating subdued expectations.

Over the week, the blue-chip FTSE 100 index was up 0.2% by mid-session on Friday, with the more UK-focused FTSE 250 was flat.

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Is there light at the end of the inflation tunnel? In this latest Charles Stanley Radio podcast, Garry White and John Redwood discuss investors’ difficult few months.

Ukraine conflict

The first grain ship to leave Ukraine since Russia invaded in February departed for Lebanon on Monday, following a deal brokered by Turkey and the United Nations last month. Russia has been blockading Ukraine's ports since the invasion, a move that has intensified concern over global food shortages, particularly in the Middle East. On Friday, Turkey’s defence ministry said that three further ships carrying Ukrainian grain had left the country’s Black Sea ports.

Global oil benchmarks West Texas Intermediate (WTI) and Brent crude fell to lows mid-week not seen since February. The slide came after US crude oil and gasoline stockpiles unexpectedly surged and as OPEC+ agreed to raise its oil output target by 100,000 barrels per day (BPD), a move equal to about 0.1% of global oil demand. There had been some hopes of a larger increase in supply by the cartel, particularly after US President Joe Biden’s recent trip to Saudi Arabia to seek help with soaring energy prices.

European supply concerns resurfaced after Gazprom, the Russian state-controlled oil group, said Canadian, EU and UK sanctions made the delivery of a Siemens turbine to the Nord Stream 1 pipeline's Portovaya compressor station “impossible”. This raised the possibility that flows through the pipeline, which Gazprom claims is now only delivering 20% of the pipe’s capacity because of these maintenance issues, will not increase before winter. German chancellor Olaf Scholz blamed Russia for the delays, accusing it of failing to take delivery of the equipment. Moscow’s aim is probably to keep Europe’s storage capacity well below full to increase leverage this winter.

Economics

The UK’s economic prospects were given a gloomy assessment by the Bank of England (BoE). The central bank announced its biggest interest rate hike in 27 years, as it forecast inflation would hit 13% in the fourth quarter of the year. It also claimed the UK would enter a lengthy recession starting around the same time. The BoE’s 50-basis-point increase took borrowing costs up to 1.75%. Inflation expectations have accelerated since the rate-setting Monetary Policy Committee (MPC) last met. In June, the central bank was forecasting peak inflation of “slightly above 11%”. The BoE thinks inflation will “remain at very elevated levels” throughout much of 2023, before falling to its 2% target “two years ahead”. With a 65% increase in Ofgem’s energy-price cap looming in October, already-elevated UK inflation is guaranteed to be given a significant turbo-charge later this year. The Bank is also treading a determined but careful path with its asset-disposal programme. The market had hoped to hear news on plans to wind down its Asset Purchase Facility (APF), which now houses £863bn of gilts and corporate debt. The Bank confirmed it will start sales in September, with about £80bn of gilts sold over a twelve-month period. This is just above the midpoint of market expectations (£50bn to £100bn). Given the profile of maturing gilts over this period, this would imply a sales programme of around £10bn, a level which is unlikely to upset markets too much. The Bank’s Governor Andrew Bailey also denied that the MPC acted too late to tackle the UK’s inflationary threat. “No-one knew a year, two years ago, that there would be a war in Ukraine,” Mr Bailey said.

British households were warned that annual energy bills could increase to an average of £3,615 this winter.

The dire warning from the BoE dominated a television debate between prospective Conservative Party leadership candidates Liz Truss and Rishi Sunak as they continue to vie for the keys to Number 10 Downing Street. Ms Truss claimed her tax cut plans could avert a looming recession, but Mr Sunak stepped up his criticisms of her £30bn plan for unfunded tax cuts. “The lights on the economy are flashing red, and the root cause is inflation,” he said. “I’m worried that Liz Truss’s plans will make the situation worse.” Mr Sunak said there will be no tax cuts until late next year if he is elected leader to get the finances of UK plc on a better footing. Nevertheless, the former Chancellor has responded to Ms Truss’s tax plans by promising the biggest income tax cut in 30 years, pledging to slash the basic rate from 20% to 16% within seven years if he emerges victorious.

British households were warned that annual energy bills could increase to an average of £3,615 this winter after energy consultant Cornwall Insight increased its previous prediction by hundreds of pounds. Greggs warned that it was increasing the price of its products following a jump in costs. The high-street baker said costs across the group were expected to rise by 9% this year.

There were also hawkish statements from key members of the US Federal Reserve. Minneapolis Fed President Neel Kashkari said it was extremely unlikely that the central bank will pivot to cutting interest rates in 2023 – futures markets are currently pricing in US rate cuts from the start of next year. “Some financial markets are indicating they expect us to cut interest rates next year," Mr Kashkari said. “I don't want to say it's impossible, but it seems like that's a very unlikely scenario right now given what I know about the underlying inflation dynamics.” St. Louis Fed President James Bullard also said the central bank will be steadfast in raising rates to bring inflation back down. Fed Chair Jerome Powell recently said the central bank may consider another "unusually large" rate hike at the September meeting. San Francisco Fed President Mary Daly said she thought next month’s meeting would have a 50-basis-point increase in mind.

Nevertheless, the US economy has shown signs of strength amid aggressive monetary tightening and runaway inflation. The American services industry unexpectedly picked up in July, as new orders grew solidly – supporting views that the economy was not in recession despite output slumping in the first half. The Institute for Supply Management (ISM) survey also showed supply bottlenecks were easing, while a measure of prices paid by businesses dropped by the most since 2017, which was partly due to declining commodity prices. Shortages of labour, especially truck drivers, persisted.

Geopolitics

Tensions continued to escalate in the South China Sea. China's foreign minister called US House Speaker Nancy Pelosi's visit to Taiwan "manic, irresponsible and irrational". Wang Yi also defended military drills in the seas around Taiwan, after China reacted by launching its biggest ever military exercises in the region. Beijing considers Taiwan to be a breakaway province under its ‘One-China” doctrine. During the visit, Ms Pelosi said that the US would not allow Taiwan to be isolated. China responded to the visit to Taiwan by the most senior US politician in 25 years by imposing sanctions on Ms Pelosi and her immediate family for her "vicious and provocative actions“, saying her trip amounted to "seriously interfering in China's internal affairs (and) seriously undermining China's sovereignty and territorial integrity." Taiwan is now bracing for a full-blown Chinese military blockade. Shares in semiconductor companies fell as chipmakers, particularly those in Taiwan, are at high risk of becoming collateral damage if there is any serious escalation of the US-China split. Taiwan plays an outsize role in the global chip-industry supply chain, with its manufacturers especially important suppliers of advanced chips. The concerns hit shares in Taiwan Semiconductor Manufacturing Co (TSMC), the world’s biggest and most valuable semiconductor manufacturer, as well as Taiwanese peers United Microelectronics and MediaTek. Meanwhile, US chipmakers such as Intel also saw their share prices weaken.

Mergers & acquisitions

US private-equity group Thoma Bravo, which specialises in technology, said it will buy Ping Identity for $2.8bn, leveraging up its presence in the cybersecurity sector. The purchase is at a 63% premium to its share price before or after any deal was announced. Thoma Bravo has been on a shopping spree in the cybersecurity space in recent years, with acquisitions including Avast, Sophos, Proofpoint and Sailpoint Technologies.

The board of hospital-chain operator Mediclinic agreed to a £3.7bn cash offer from a consortium of its biggest shareholder and a shipping company. Mediclinic is based in South Africa but also operates in Switzerland, Namibia and the United Arab Emirates. It also owns almost 30% of UK provider Spire Healthcare. The buyers are Remgro, the investment vehicle of the Rupert family, which already owns a 45% stake, and Mediterranean Shipping Company, a container shipping group. Remgro’s investments range from healthcare and infrastructure to financial services and media.

Corporate reports of note

The impact of Russia’s war in Ukraine on energy markets has resulted in BP posting second-quarter profits of £6.9bn – its highest in 14 years and the second-highest quarterly profit in its history. The news came days after record profits were reported by rival Shell, as well as the two largest US oil companies – ExxonMobil and Chevron. BP increased its dividend by 10%, more than its previous guidance of 4%, and announced a new $3.5bn share buyback.

High-street stalwart Next raised its annual profit guidance after the group discounted fewer items than expected. Full-price sales were 4.7% stronger than expected in the second quarter to 30 July, which Next said was due to “unusually warm and dry weather in June and July”. Management does not expect the strong performance seen in the second quarter to continue into the second half, so the retailer is keeping its sales-growth guidance for the remainder of the year unchanged at 1%.

Shares in engine manufacturer Rolls-Royce slumped after chief executive Warren East warned about the continuing impact of supply-chain problems and inflation. He said the company was suffering “post-Covid indigestion” as the group posted a set of below-expectations second-quarter results. Rolls-Royce has been hit especially hard by the Covid-19 pandemic because its revenues are closely linked to the number of hours its engines are airborne. The turbine maker provides engines for aircraft such as Airbus’s A350, which are primarily used on long-haul routes, a part of the industry that has not recovered as quickly as short-haul.

Shares in electronic payments group PayPal jumped after management raised its annual profit guidance and unveiled a $15bn share buyback. It was also revealed that activist investor Elliott Management had built a stake worth more than $2bn in the company.

Starbucks second-quarter numbers demonstrated the damaging economic impact of China’s strict ‘zero-Covid’ policy. Sales at Chinese stores open for more than a year slumped 44% in what was once the group’s fastest-growing market. Nevertheless, the coffee-shop chain beat Wall Street estimates for quarterly profits as higher prices and strong demand for its coffees in the US offset the hit from China.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Bank of England warns on inflation and growth

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