DROP IN HEADLINE INFLATION PROVIDES POSITIVE MOMENTUM FOR MARKETS

DROP IN HEADLINE INFLATION PROVIDES POSITIVE MOMENTUM FOR MARKETS

This week David Cameron’s return from the political wilderness caught everyone by surprise. Cameron is the first former prime minister to return to government since 1970 as he takes up the role of Foreign Secretary. His appointment dominated the headlines and successfully attracted attention away from Suella Braverman’s acrimonious departure from government. But Cameron’s return doesn’t do much for the government in the longer term. It remains far behind in the polls and the recent King’s Speech had little to allow it to regain political momentum.

The positive reaction to this week’s inflation figures suggests markets are also being distracted by short-term news. Despite the big drop, UK CPI is only 0.3% below where the market had expected it to land as falling domestic energy bills take effect and, in line with the recent trend, core inflation remains sticky. The decline is welcome but does little to change the outlook. Very low unemployment and strong wage inflation means the Bank of England may be convinced to keep rates high for a while. Meanwhile, falling retail sales suggests the risk of recession is still live.

INFLATION: MARKETS RISE AS INFLATION FALLS FASTER THAN FORECAST

A big drop in headline inflation has given a boost to global markets. After several months of meagre reductions, UK CPI inflation dropped from 6.7% to 4.6% in October. The slowdown was more than expected as lower domestic energy costs took effect. US headline inflation also fell more than expected as CPI dropped to 3.2% from 3.7%. However, core inflation (excluding volatile energy and food prices) remains sticky. Core US inflation fell from 4.1% to 4%, and core inflation in the UK fell from 6.1% to 5.7%.

Slowing inflation added momentum to last week’s rally. Government bonds increased again and this sent UK gilt yields (which move inversely to bond prices) to their lowest since late May. Positive inflation updates also helped to lift most global equity markets and saw the dollar fall against most major currencies. However, markets remain wary that central banks may keep interest rates high as inflationary pressures remain. In the UK pay inflation has slowed slightly but average wages excluding bonuses are 7.7% higher than last year.

CHINA: RETAIL SPENDING RISES BUT PROPERTY STILL IN THE DEEP FREEZE

Chinese consumer spending jumped in October and industrial output increased more than expected. Retail sales grew by 7.6% compared to last year driven by an increase in discretionary spending. This is a contrast to recent data which showed the country in deflation as the consumer price index fell by -0.2% in October. Meanwhile, a decline in new bank loans shows consumers and businesses remain cautious.

Official data shows the unemployment rate unchanged at 5%, but unofficial measures put the real figure much higher, with youth unemployment above 20%. The International Monetary Fund recently upgraded China’s outlook and predicts GDP growth of 5.4% in 2023 due to government stimulus. This stimulus may have raised consumer spending but the property sector continues to struggle despite official attempts to restore demand as Chinese property prices are falling at the fastest rate in eight years and the sector continues to act as a drag on the wider economy as Chinese equities fell slightly this week.

EQUITIES: LUXURY GOODS FEELING THE CHILL OF LOWER DEMAND

Burberry shares led a decline in luxury goods makers as it reported slower sales growth. Burberry forecast annual profits at the lower end of its range of £552m to £668m as revenues for the six months to September grew by 4%. This is a big drop from the 18% increase recorded in the first quarter. Burberry attributed the slowdown to high inflation and customers feeling the effects of the rising cost of living.

Burberry is the latest luxury brand to report that demand is slowing. Richemont and LVMH have also warned about slowing sales, with lower demand from Chinese highlighted as a particular issue. Demand in the US has so far held up but this week brought news that US retail sales fell in October. This is the first monthly decline since March. Burberry’s update caused its shares to fall by 9% on Tuesday and this had a knock-on effect as Kering, LVMH and Richemont all decreased this week and this continues the sharp decline in the sector since shares peaked in July.