Foreign Currency
Sterling is, once again, marginally higher against major currencies, following a sharp upturn in UK consumer price inflation. The underlying trend in the US dollar is slightly negative given the current focus on the problems of the US financial sector. Short term, against the euro, sterling remains in consolidation mode, given that both the eurozone and UK economies are in a slowdown phase, close to the low point of the economic cycle. Against the euro, sterling’s trading range remains circa £0.78-0.8050. Against the dollar, sterling’s trading range has firmed marginally to circa $1.96-2.02.
Interest Rates
Period rates are marginally lower reflecting the continuing downturn in equity markets. There was minimal reaction to the unexpectedly sharp increase in UK inflation. The consumer price index (CPI) rose by a remarkable 0.5% pa to 3.8% pa. However, the largest increase was in the food sector, partly due to seasonal and weather related factors. Yesterdays’ output data indicates that the peak in target inflation, CPI, is likely to be well over 4%. Recent MPC member comments indicate an acceptance that there is nothing the MPC can do about short-term inflationary pressures. In respect of longer term global inflationary pressures, the MPC’s options are limited, given they are unlikely to jeopardise the government’s wider economic objectives. The increase in RPI was less pronounced – from 4.3% to 4.6%. The key factor is whether higher inflation feeds into pay settlements in the public sector. There is less likelihood of a significant upturn in earnings in the private sector given the pressure on profit margins. At present, our view remains that UK base rate will remain at 5% throughout second half 2008. On a longer- term view, period rate sentiment may well alternate between a view that next move in base rate will be up and view that next move is down. In the short term, 2 year plus rates may well continue to be driven by international factors, primarily movements in global equity markets.
Equities
World equities have fallen significantly on renewed credit concerns. Many western indexes closed at new 2008 lows yesterday. Overnight there was a recovery in the Nikkei 225, following the fall in crude oil prices. This benchmark index remains well above the 2008 low point, given the strength of the Chinese economy, a major Japanese trading partner. There may be further downside in the coming weeks as the credit crunch exerts its maximum impact. In September, we expect sentiment will slowly improve given the increasingly large number of stocks that are in oversold territory and the probability that central banks will announce a further injection of liquidity within the next three months.
Oil and other Commodities
Brent crude has fallen by over nearly $5/ barrel in response to unease over the path of western economies, and hence crude oil demand. Metal prices are experiencing a brief period of stability, with the gradual slowdown in the global economy balancing the pressures on supply.