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WeekWatch -‘The game of Musical Chairs to find Boris Johnson’s successor became increasingly bitter last week’ July 22

WeekWatch -‘The game of Musical Chairs to find Boris Johnson’s successor became increasingly bitter last week’ July 22

In Germany it’s called “Reise Nach Jerusalem”, a name thought to be inspired by the Crusades. Whether or not that’s true, the game of Musical Chairs to find Boris Johnson’s successor became increasingly bitter last week. By Thursday, there will be just two candidates and one chair remaining.

Tax cut promises have been a dominant theme in the campaign, despite the Office for Budget Responsibility warning that UK debt is on an “unsustainable path” unless spending is tightened and taxes are raised. In an open letter last week, the CBI business group added its concerns, urging the candidates to focus on growth and an overhaul of the tax system over quick cuts. It described the level of inflation pressure on households and businesses as “eye-watering”.

Inflation figures for June will be released this week, as will the latest employment numbers, which should provide strong indicators of whether the Bank of England will speed up interest rate rises. The pressure to do so increased last week as GDP figures for May came in better than expected. Against consensus forecasts of no growth, the UK economy expanded 0.5%, driven by healthcare services and a bounce back in the manufacturing and construction sectors.

However, June is likely to show a large contraction due the additional Platinum Jubilee bank holiday and the disruption to transport services from industrial action. The current heatwave also looks set to dampen activity this month, especially for the retail sector.

The British Retail Consortium reported that retail sales are falling at a rate not seen since the depths of the pandemic, underlining the pressure on households’ finances. Sales in shops and online have dropped for three months in a row, with furniture, home appliances and computing the biggest fallers.

Despite growth concerns, the pressure is on the Bank of England to keep raising interest rates to reduce the risk of higher inflation becoming entrenched. “The next Monetary Policy Committee meeting on 4 August should deliver an increase in interest rates of at least 0.25%,” commented Azad Zangana, Senior European Economist at Schroders. “The argument for a larger rise, however, is strengthening.”

Surging inflation was also the story in the US last week. Inflation in the 12 months to June hit 9.1%, the highest level for more than 40 years, with fuel and food costs the main drivers. The finances of American families are being hit hard, with evidence that people are changing their spending habits and using savings to pay for housing and food.

Whilst downplaying the backward-looking figures, President Biden’s administration will be concerned, with midterm elections looming in November and its popularity falling as inflation has soared.

Markets had already priced-in expectations of a three-quarter point interest rate hike from the Federal Reserve at the end of this month, but the hotter-than-expected inflation figures sent Wall Street lower on Wednesday on fears of a full percentage point rise. However, by the end of the week, news of a surprise gain in retail sales and comments from Fed officials reversed those expectations and US stocks recovered ground.

Last week also saw the euro fall below the dollar for the first time in 20 years. The euro has been weakened by fears that restrictions on energy supplies from Russia will increase the risk of recession, as well as concerns that the European Central Bank has lagged other central banks in raising rates.

A weakening currency will make imports more expensive for eurozone countries, especially goods priced in US dollars such as crude oil, creating higher inflation pressure, which is already running at 8.6%.

Official data released last week confirmed that China, the world’s second largest economy, has been hit hard by recent COVID-19 lockdowns. Activity contracted sharply in the second quarter, with GDP falling 2.6% from the previous quarter. There were some bright spots in the data. Unemployment fell to 3.5% and retail sales outperformed, although many analysts do not expect a quick recovery as the government continues with its strict zero-COVID approach to slowing the spread of the virus.

Ahead of a meeting of G20 finance ministers and central bank governors in Bali, the head of the International Monetary Fund, Kristalina Georgieva, said it would downgrade its expectations of global economic growth this month. She warned that the outlook had “darkened significantly” due to the impact of the war in Ukraine, higher inflation, and the ongoing COVID-19 pandemic, and said that central bank action on interest rates will “need to continue”. The IMF reported that 75 central banks have raised interest rates in the last year, on average, 3.8 times.

The end of the week provided more positive news as Turkey announced that a deal was in sight to end the Ukrainian grain blockade. Russia, Ukraine, Turkey and the United Nations are now due to sign a deal next week.

Schroders is a fund manager for St. James’s Place.

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