Market Commentary 15th January 2024 – from Charlie Hancock

The UK economy expanded by slightly more than expected in November, according to initial estimates. The economy grew by 0.3%, following a contraction of 0.3% in October, indicating that activity was broadly flat for the 2 month period. Service based industries were the main contributor to growth during November, with manufacturing and construction still relatively weak.

With the UK economy shrinking marginally during the 3^rd quarter, December’s Gross Domestic Product (GDP) data will determine whether the UK technically entered recession during the final quarter of 2023. Although the economy has been sluggish over the last year, there are hopes that the recent fall in inflation will contribute to improved consumer sentiment and therefore increased economic activity.

Eurozone economic data released last week painted a relatively gloomy picture, however, the labour market appeared to be relatively stable during November, with no significant increase in unemployment. The unemployment rate declined slightly, down to 6.4% from October’s 6.5%. The number of vacancies continued to shrink, but overall the labour market appeared to remain relatively tight.  Retail sales data for November came in worse than expected, whilst industrial output in Germany was also considerably weaker than expected.

The President of the European Central Bank (ECB), Christine Lagarde, made some dovish remarks during an interview last week. Lagarde said that she does not think rates will continue to go up and that “the worst part is behind us” regarding inflation.

Investors paid close attention to December’s inflation data. The Consumer Price Index (CPI) saw a bigger than expected year-on-year increase of 3.4% during December, up from the 3.1% rate of inflation recorded for November.

The acceleration in headline inflation prompted speculation that the Federal Reserve may not proceed with any rate cuts in the coming months, however, analysts pointed to generally weak inflation across most categories of goods and services, with shelter (housing) costs being a significant contributor to the headline number for December.

Producer Price Inflation (PPI) data, which measures output costs from the manufacturers of goods and services, also helped to alleviate concerns around a resurgence in inflation. Producer prices declined for the third month in a row in December, falling by 0.1%.

Chinese economic data appeared to prompt further weakness in investor sentiment, with December’s inflation data showing that the economy remains in deflationary territory. Calls for monetary stimulus intensified and the People’s Bank of China (PBOC) hinted that reserve requirements for banks may be loosened to try and stimulate lending. President Xi reportedly ramped up calls for a crackdown on corrupt organisations and individuals last week. It was reported that Xi said there would be “no mercy” towards corruption in the financial, energy and pharmaceutical sectors.

Investors appeared to price out concerns that the Bank of Japan (BoJ) would tighten monetary policy in the near future last week, prompting a decline in Japanese government bond yields and a rise in equity valuations. The central bank are carrying out further analysis regarding the economic impact of the recent earthquake. Inflation data showed that prices in Tokyo rose by 2.1% year-on-year during December, marking the weakest inflation since mid 2022, which further supported bets that the BoJ will not hike interest rates in the near future.

Economic data for the UK painted a mixed picture, but overall it solidified the belief that the economy remained sluggish during the final quarter of 2023. At present, markets expect it is unlikely the Bank of England (BoE) will implement further rate hikes during the current cycle.

The week’s Eurozone employment data may have contributed to the rise, however, other economic data painted a picture of weak growth, which would not support any significant rise in yields from here.

Fixed income traders appeared to shrug off December’s CPI data. Although the headline number showed inflation accelerated during the month, markets appear confident that the Federal Reserve will cut interest rates by the middle of 2024.

GBP / EUR – Current 1.1644 Previous 1.1624

The Pound gained 0.26% against the US Dollar last week and 0.17% against the Euro. Hopes that the UK economy could avoid a recession may have contributed to currency traders being positive on Sterling last week.