The summer months have given us reason to be cautiously optimistic that we are moving away, albeit slowly, from two of the main themes that have characterised the past year – rising inflation and interest rates.
In August, the Bank of England (BoE) increased interest rates again by 0.25% to 5.25%, but indicated that it intended to hold rates at this level for some time. In September, the BoE was true to its word, with interest rates remaining the same following the 20 September Monetary Policy Committee meeting. This ended a run of 14 consecutive increases.
This decision was made in part due to the welcome fall in the rate of inflation which eased further in line with expectations to 6.7% year on year, down from 6.8% in July, according to the Office for National Statistics.
This wasn’t the only surprise, with the UK economy overall performing better than expected, with GDP rising 0.2% quarter on quarter vs expectations of 0%. Salaries excluding bonuses were at their highest since records began in 2001, up 7.9% year on year in the period April to June. This is a concern to the BoE as it indicates that consumers are more likely to be able to keep up with rising prices, slowing the easing of inflation. Whilst chances of rates actually starting to fall look slim at the moment, the slowing rate of inflation will be welcome news to many.
Interest Rate Rises Expected in US and EU
At the beginning of August, the US saw its credit rating downgraded by rating agency Fitch from the highest level AAA to the second highest AA+ given concerns around increased political dysfunction and the sustainability of debt and deficit trajectories. This may have had some bearing on the increase of US treasury yields later in the month, but these were probably more driven by strong economic data and higher treasury issuance.
Unemployment in the US fell to 3.5% during July (although job gains at 187,000 were slightly below expectations) whilst average hourly earnings were slightly above expectations. Retail sales increased 0.7% month on month in July, well above expectations of a 0.4% month on month rise. CPI inflation rose slightly to 3.2% but core CPI (which excludes food and energy) fell to 4.7%, from 4.8% in June. Central bank communication was consistent with market expectations of one more 0.25% rate increase before cuts begin next year.
In the Euro Area GDP grew an estimated 0.3% quarter on quarter in Q2 2023, with unemployment dropping to 6.4% in June, its lowest on record. The outlook remained muted, however, with the August composite purchasing manager index (CPI) falling to 47, its lowest since 2012 (barring those associated with COVID). Although headline CPI remained flat at 5.3% year on year, core CPI did fall slightly in August to 5.3% from 5.5% in July. As this remains higher than the European Central Bank’s target, markets are still pricing in further rate increases before the end of the year.
Weaker Than Expected Chinese Economic Data
In Emerging Markets, Chinese economic data was much weaker than expected. CPI turned negative in July at -0.3% year on year with producer price index deflation continuing for the 10th month in a row. Retail sales also badly missed expectations, growing 2.5% year on year vs expectations of 4.5%, with consumer confidence remaining low. Private investment decreased 2.3% year on year in July with the property sector remaining the weakest sector, down 8.5% over the January to July period compared to the previous year. On the plus side, Chinese officials kicked off further stimulus, with the People’s Bank of China lowering its interest rate twice in August and Beijing cutting stamp duty on stock trading towards the end of the month.
Currency Performance
Overall, it was a mixed quarter for Sterling. In August, Sterling underperformed the Dollar (down 1.5%) but was flat vs the Euro, 0.9% stronger vs the Japanese Yen and up 2.5% vs the Australian Dollar. Against emerging market currencies, the pound was up 4.9% versus the South African Rand and up 2.5% against the Brazilian Real.
Asset Class Performance
August was a negative month for most asset classes. Emerging market equities were the worst performing equity asset class whilst commodities were the best, due in part to a stronger dollar in which most commodities are priced (US equities also held up relatively well on the back of a stronger dollar).
Within UK equities, mid-sized larger companies performed roughly in-line. The large-cap FTSE 100 was down 2.5%, whilst the mid-cap FTSE 250 index was down 2.4%.
Bonds also sold off slightly over the month, with Emerging Market bonds worst hit in a difficult spell for the region.
The past 18 months have been difficult, and it is very easy to be gloomy when looking at recent past performance. However, despite the ongoing near term challenges and uncertainty, the long term outlook has dramatically improved which is good news for investors everywhere.
