Overview
Inflationary pressure continued to ease across most of the developed world during August and headline inflation in the UK fell to the lowest rate since before Russia’s invasion of Ukraine.
However, whilst inflationary pressure is easing, most economies are straining under the pressure of higher interest rates.
The Bank of England chose to raise rates by another 0.25% in August to 5.25%. However, the Monetary Policy Committee is becoming more split on the way forward.
Elsewhere there were more signs of trouble brewing in the Chinese economy.
Not only did consumer prices fall in the year to July (i.e. deflation) but youth unemployment exceeded 20% in the latest official stastics before the authorities decided to discontinue their publication.
Over the last 6 months the FTSE 100 returned -3.45%, the S&P 500 returned 14.75%, whilst the Euro Stoxx 50 returned 4.00%.
The Japanese Nikkei 225 returned 18.54% over the same period.
The broad emerging markets index returned 1.50% in US$ terms.
10 year UK Gilt yields rose substantially during the middle of the month before falling back to end the month broadly flat.
10 year US Treasury yields rose slightly over the month.
US Economic News
US headline inflation ticked up slightly to 3.2% in the year to July. However, a small increase was expected and the actual figure was marginally better than the 3.3% forecast.
Despite headline inflation falling significantly over the last 12 months the US Federal Reserve pressed ahead with a further 0.25% rate rise.
The reason the Central Bank remains cautious is that the labour market continues to look ‘tight’ – the unemployment rate remains historically low and there are a high number of vacancies.
On the other hand the broader economy showed signs of softening during August, which should reduce inflationary pressure further.
The latest surveys suggest the world’s largest economy expanded at the slowest pace since the start of the year and is now close to contracting as the fourth quarter approaches.
Adding further evidence to the notion that the labour market will begin to loosen is the fact that US job openings fell to the lowest in two years.
UK Economic News
The headline rate of inflation in the UK fell to 6.80% in the year to July. This was in line with expectations and represents the lowest rate of inflation since before the Russian invasion of Ukraine.
However, the core inflation rate remains at 6.9% and the Bank of England felt forced to raise rates by another 0.25%.
Interestingly the MPC is becoming increasingly divided on how to proceed.
The August vote resulted in a 6-3 majority with two members preferring a 0.50% rise and one member preferring a cut to 5.00%.
In a similar story to many other developed economies the UK economy is estimated to have slowed during August.
In fact the most recent indicators suggest the UK economy contracted in the month of August and is now likely to contract over the third quarter as a whole.
Although the UK labour market remains tight by historical standards there is now clear evidence that higher interest rates are beginning to have an effect.
The unemployment rate rose to 4.2% in the three months to June 2023, which is the highest rate of unemployment since 2021.
A loosening jobs market will start to exert downward pressure on wages (and inflation) but in the three months to June average regular pay surged by 8.2%.
Eurozone Economic News
Inflation across the Eurozone was unchanged at 5.3% in the year to August, surprising forecasters who were expecting another slight fall.
At the same time the latest surveys pointed to a significant downturn across the single currency region.
Taken together they suggest the economy is contracting at the fastest rate since November 2020. If the recession during the COVID pandemic is excluded then the contraction is the fastest since April 2013.
Growth in the Eurozone’s largest economy, Germany, was confirmed at 0% for the second quarter of the year. This follows negative growth in the two previous quarters.
The headline rate of unemployment across the Eurozone was unchanged at 6.4%. However, with companies becoming less positive about their future prospects, unemployment is expected to rise in the future.
Wider Economic News
There were further discouraging signs for the Chinese economy during August as it was revealed consumer prices fell for the first time in 2 years. This suggests lacklustre demand within the economy.
At the same time the country has a significant youth unemployment problem. The figure reached more than 20% before the authorities announced they would discontinue the publication of youth unemployment statistics.
Elsewhere the Japanese economy maintained solid momentum thanks to an acceleration in the services sector.
The manufacturing sector on the other hand deteriorated slightly as global demand cooled.
Financial Markets and Corporate News
Equity market returns over the last 6 months were again dominated by a small group of large US firms.
Over the last 6 months the FTSE 100 returned -3.45%, the S&P 500 returned 14.75%, whilst the Euro Stoxx 50 returned 4.00%.
The Japanese Nikkei 225 returned 18.54% over the same period.
The broad emerging markets index returned 1.50% in US$ terms.
UK Gilt yields rose substantially in the middle of August before falling back towards the end of the month.
The Investment Association (IA) UK Gilts sector returned -2.57% over 6 months, whilst the IA Sterling Corporate Bond sector returned -0.32% and the IA Sterling High Yield sector returned 2.73%.
Summary of Key News:
- UK inflation fell once more but remains high.
- The Bank of England raised interest rates for the 14th consecutive time.
- The US Fed also raised rates despite signs of a slowing economy.
- The Eurozone economy weakened whilst inflation was higher than expected.
- The Chinese economy has some significant problems and is experiencing deflation.
- The Japanese economy continued to exhibit good momentum.
Financial Markets:
- Over 6 months the FTSE 100 returned -3.45%, the S&P 500 returned 14.75%, and the Euro Stoxx 50 returned 4.00% (total return).
- The Japanese Nikkei 225 returned 18.54% (total return).
- The broad emerging markets index returned approximately 1.50% (in US$ terms).
- The IA UK Gilts sector returned -2.57% over 6 months, whilst the IA Sterling Corporate Bond sector returned -0.32%, and the IA Sterling High Yield sector returned 2.73%.
Outlook
Inflationary pressure is clearly reducing across most of the developed world.
However, the question on investors’ minds is whether Central Banks will need to keep their foot on the brake for so long that their respective economies suffer a ‘hard landing’ and an extended recession.
The Bank of England and European Central Bank arguably have the hardest job in this regard as core inflation remains very high whilst the economies teeter on the verge of recession.
With forward-looking indicators pointing to rapidly falling inflation the Bank of England may be making a mistake if it presses ahead with more rate rises.
The more nuanced situation is highlighted by the fact that the Monetary Policy Committee is becoming more divided on how to proceed.
If the situation wasn’t complex enough the deterioration in China’s economy has only added another factor to consider for policymakers.
China has a huge effect on the prices of goods around the world and if deflation were to persist then inflation around the world would fall more rapidly than currently expected.
With the interest rate outlook now quite different across the major regions of the world there is the potential for substantially different investment trends.
The other factor to be considered where stocks are concerned, is how well company earnings hold up.
With lacklustre growth around most of the world, many companies have struck a cautious tone on future earnings growth.
During August stock markets were once again led by a narrow group of large US companies.
This ‘narrow’ market cannot continue indefinitely and at some point stock market returns would be expected to broaden out.