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Market commentary

In the interim period before a new Prime Minister is installed, the outlook for economic policy naturally looks uncertain. Until his resignation earlier in July, Chancellor Rishi Sunak was expected to give a joint speech on the economy with Boris Johnson. For a long time, press reports suggested clashes between Sunak’s more fiscally cautious stance and Johnson’s more free-spending attitude. These were confirmed in the Chancellor’s resignation letter.

Sunak’s departure paved the way for a more sympathetic attitude to Johnson’s view by the next Chancellor, Nadhim Zahawi, promoted into this role on Tuesday. Indeed, Zahawi indicated in press interviews that the planned hike in the corporation tax rate from 19% to 26% in 2023/24 could potentially be scrapped to maintain global competitiveness. He is said to have been instructed to look into immediately cutting fuel duty and perhaps also the standard rate of VAT as well as income tax rates, along with lifting the tax thresholds with inflation, to help address the rising cost of living. Similarly, he is reported to oppose windfall taxes on oil and gas companies. At the same time, though, he noted the need to be fiscally responsible to rein in high and rising inflation, including by being ‘really careful’ as regards public sector pay.

One could argue that Mr Johnson’s departure removes, or at least lessens, some of the downside risks facing the pound. In discussions over the Northern Ireland protocol, Boris Johnson’s Government has become increasingly hostile towards the EU in recent months, running the risk of increasing trade frictions with the EU. In addition, as public dissatisfaction with the UK Government grew, Scottish independence may have seemed more appealing to Scottish voters. The SNP’s request for a second referendum has been rejected, but Scottish First Minister Nicola Sturgeon maintains that the next general election will become a ‘de facto’ referendum if no second vote is permitted. A change at No. 10 may help to douse Scottish appetite for separatism.

20th July 2022


UK monthly Gross Domestic Product (GDP) figures for May, reported a large and broad-based rebound in real economic activity. Notwithstanding the cost-of-living surge and intense price pressures for raw materials, GDP increased by 0.5%. Moreover, there were upward revisions to the back data too, with March and April numbers slightly higher than previously reported, respectively.

The overall picture is that output gains were broad-based, with large gains from health and social care (+2.1%), manufacturing posting its largest monthly rise since November 2020 (+1.4%) and construction jumping by 1.5%. Even consumer-facing services were down only 0.1%, as clearly weaker spending on sports activities, amusement and recreation activities (-5.3%) and lower retail sales (-0.5%) in the face of higher costs were largely offset by a surge of 11% in travel-related services.

This is consistent with an uneven picture of spending across the population. Whereas some parts of consumer spending are evidently suffering, others are still benefitting from pent-up demand and the high stock of savings to fund it. In other words, for the time being, there is little sign that the cost-of-living crisis, coupled with the National Insurance Contributions hike, is causing a spending crunch in the country as a whole.


There were reminders of the eurozone crisis recently as the European Central Bank begins to contemplate raising interest rates, the more indebted European countries saw their borrowing costs soar as government bond yields, particularly in Italy rose sharply relative to those of Germany. The focus remains on Italy owing to its high levels of debt relative to other countries and also because its politics remain a concern.

While the current President of Italy and former President of the European Central Bank, Mario Draghi is seen as a safe pair of hands, we are less than a year away from a general election which might leave a less reliable leader at the helm.

Over the last month there have been fears that Russia may not reopen the Nord Stream 1 pipeline, citing testing needs or other issues. This is a natural gas pipeline that links Russia and Germany under the Baltic sea. If there is such a delay it will be difficult to work out how much of this is political and how much of it reflects a genuine need to repair and test the turbines powering the line. While this may not have too much impact in the short term the German head of gas networks has said Germany would struggle without Russian gas over the winter.


US monetary policy remains the dominant factor for global liquidity. It is transmitted to the world through the dollar. For example, with many global commodities being priced in dollars, a strong dollar just adds to cost pressures. Much of the debt around the world, especially in Emerging Markets, is denominated in dollars, meaning that the borrowers must pay more in terms of their local currencies to service and repay those liabilities.

With the rapid increase of interest rates in the US to try and curb inflation, this has led to a further strengthening of the dollar and there are concerns this will lead to recession in a number of emerging economies.

Emerging markets

There has been some recovery in market sentiment towards Emerging Markets, although it is hard to see them rallying strongly until the dollar has confirmed a peak.

Countries such as Sri Lanka illustrate the turmoil that can quickly ensue once foreign investors lose confidence, but even a stronger country such as India has seen its currency, the Rupee, hit record lows against the dollar as its terms of trade have suffered from the rising costs of energy.

China remains the driving force for Emerging Market indices, comprising 31% of the market value. Here, the zero-Covid strategy continues to play havoc with short-term economic growth as the Government attempts to balance a reflation strategy against a desire to contain the more speculative behaviour of investors in both the housing and stock markets. The next big set piece will be the 20th Party Congress held by the Chinese Communist Party which will take place this autumn (date not yet confirmed). This forum will elect the senior leadership for the next five-year cycle and set out the strategic road map, as well as confirm the third term of President Xi. This event should provide greater policy clarity.

Defensive assets

Investors’ concerns through June shifted from inflation to recession. While equity markets hit new lows for the year during June, Government bonds rallied as their prices increased because of the fall in yield. For example, the US 10-year Treasury yield fell from a peak of 3.49% to as low as 2.80%. The 10-year UK Gilt yield fell from 2.65% to 2.04%. Falls in yield of such magnitude and speed have only been witnessed in this century during the Financial and Covid crises.

The message from bond markets is that they believe central banks will do enough to prevent inflation becoming embedded and this is reflected in the average ten-year inflation market expectation. We often get asked whether inflation will stay high. In the UK, the average ten-year inflation market expectation has fallen from 4.63% in April to 3.69%, while in the US it has fallen from 3.03 % to 2.34%.

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