CAPITALDIGEST MARKET REVIEW, 17/10/2022

STERLING FALLS NEAR TWO-WEEK LOW AFTER BAILEY MESSAGE The British pound dropped to its lowest level in almost two weeks on Tuesday, a day after Bank of England governor Andrew Bailey reiterated the central bank’s cautious message from the mid-March policy decision. Bailey said on Monday that the BoE had started to see evidence of an economic slowdown, which it expects to weigh down on domestically generated inflation. The central bank raised its interest rate for the third consecutive meeting earlier in March, but softened its language on the need for further rate hikes. Money markets are currently pricing in a further 133 basis points of tightening from the BoE by the end of the year IRPR but Commerzbank FX and EM analyst You-Na Park-Heger thinks the key rate at around 2% by year-end seems exaggerated. “The market expectations are likely to be further fuelled with each set of high inflation data, but once signs that the British economy is weakening further increase the market might have to adjust its expectations to the downside,” Park-Heger said. “Medium-term we therefore see downside risks for Sterling.” U.S. DOLLAR RISES, YEN NOT FAR FROM 24-YEAR TROUGH THAT PROMPTED INTERVENTION The safe-haven U.S. dollar gained broadly in volatile trading on Tuesday, adding to recent gains, after a top Bank of England official reiterated that the central bank will end its bond-buying program on Friday and told pension fund managers to finish rebalancing their positions within that time frame. That fuelled concerns that the BoE’s withdrawal could re-ignite market volatility around the world and cause financial instability. BoE Governor Andrew Bailey said pension funds should finish rebalancing their positions by Friday when the British central bank is due to end its emergency support program for the county’s fragile bond market. Earlier on Tuesday, the Pensions and Lifetime Savings Association, an industry body, urged the BoE to extend the bond-buying programme until Oct. 31 “and possibly beyond.” Sterling dropped to a two-week low of $1.0962 GBP=D3 after Bailey’s remarks, down 0.9%. Adding to the gloom was a downbeat report from the International Monetary Fund that said countries representing a third of world output could be in recession next year. The IMF also cut its 2023 global growth forecasts further.  STERLING AWAITS FOR BOE DEADLINE, FRAGILE YEN TESTS 1998 LOW Sterling fell on Thursday, marching towards Wednesday’s almost two-week low, as investors nervously awaited an impending deadline for the end of the Bank of England’s emergency bond-buying programme. A fragile yen languished near a fresh 24-year low, while markets were also on edge ahead of U.S. inflation data due later in the day for possible clues on how much higher the Federal Reserve will push interest rates. Sterling eased 0.1% to $1.10860 at 0808 GMT, following a 1.25% rebound in the previous session after the Financial Times reported that the BoE had signalled privately to lenders that it was prepared to extend its emergency bond-buying programme beyond Friday’s deadline if market conditions demanded it. However, the central bank later reiterated that its programme of temporary gilt purchases will end on Oct. 14. At the same time, Britain’s new government said on Wednesday that it would not reverse its vast tax cuts or reduce public spending – a plan which has wreaked havoc in the country’s financial markets. On Thursday, BoE said   DOLLAR EDGES HIGHER DESPITE INFLATION, PUSHES YEN TO NEW 32-YEAR LOW The dollar edged higher on Friday after dropping the previous day despite U.S. inflation accelerating, helping it hit a 32-year peak against Japan’s yen. Sterling slipped after a sharp rally on Thursday, as reports said British Prime Minister Liz Truss was preparing to sack her finance minister and carry out a major U-turn on the government’s tax plans. The dollar index was last up 0.35% to 112.97, having fallen 0.6% on Thursday as investors seemingly brushed off data that showed U.S. consumer prices increased more than expected in September. The greenback has been on a tear this year as the Federal Reserve has ramped up interest rates in an effort to tame inflation, pulling money back towards the United States. Fears about the global economy have also boosted the safe haven asset.Yet, the stronger-than-expected inflation data on Thursday counter-intuitively triggered a rally in global stock markets and a fall in the dollar. Analysts suggested short-sellers reversing their positions seemed to have driven the bounce in equities, weighing on the dollar. STERLING REBOUNDS ON UK FISCAL POLICY U-TURN; YEN STRUGGLES Sterling edged higher on Monday following British Prime Minister Liz Truss’s partial reversal of her government’s economic plan, while the yen was pinned near a 32-year low as markets awaited signs of intervention from Japanese authorities. The pound gained 0.6% to $1.1245 in early Asia trade, after Truss said on Friday that Britain’s corporation tax will rise to 25% from April next year instead of keeping it at 19% as part of her government’s initial “mini-budget”. The news came hours after she sacked former finance minister Kwasi Kwarteng, with Jeremy Hunt replacing him. Hunt, a former foreign and health minister, has promised to win back Britain’s economic credibility by fully accounting for the government’s tax and spending plans, while insisting his boss Liz Truss remained in charge of the country. British lawmakers will try to oust Truss this week despite Downing Street’s warning that it could trigger a general election, the Daily Mail reported. All eyes are now on how the UK government bond market will trade, after the Bank of England on Friday concluded its emergency gilt market support.