FX Daily: UK’s U-turn on tax cuts and RBA’s rate hike


Cautious about GBP and AUD at current levels
Group Research, Philip Wee04 Oct 2022
    Photo credit: Unsplash Photo


    GBP appreciated 1.4% to 1.1323 after the Truss government dropped a plan to scrap the 45% top income tax rate on the highest earners. Only a week ago, the GBP plunged to a new record low of 1.0350 on 26 September. The pound’s recovery was fuelled initially by the Bank of England’s Gilt buying programme to 14 October (aimed at averting a full-blown pension crisis) and later by its hint for a jumbo rate hike at its next meeting on 3 November. However, it is premature to conclude that the worst is over. Although the 10Y Gilt yield eased to 3.964%, it held around the levels of the mini-budget announcement on 23 September. So was the GBP. 

    Last Friday, Standard and Poor’s downgraded UK’s debt rating outlook to “negative” from “stable”. Chancellor Kwasi Kwarteng still needs to explain how the government will fund the remaining GBP43bn package of tax cuts. BBC reported that the details could arrive later this month instead of 23 November, and possibly lead to another Tory rebellion over cuts in public spending. According to Reuters, Moody’s considered the tax cuts as credit negative and may conduct a formal review on 21 October. However, Prime Minister Liz Truss attributed the market turmoil to poor communication, still brushing aside the criticisms of the policy. If markets view the U-turn on the tax cut as throwing a bone to the dogs, selling pressures will resume.

    AUD was one of chief beneficiaries of the relief rally, appreciating 1.8% to 0.6516, its highest close since 23 September. However, AUD has yet to break above last week’s trading range between 0.6363 and 0.6550. Today, we see the Reserve Bank of Australia lifting the cash rate target by 50 bps to 2.85%, above the 2.5% neutral rate. The Australian Bureau of Statistics reported that CPI inflation eased to 6.8% YoY in August from 7% YoY in July. Taken together, inflation in 3Q22 will be higher than the 6.1% average in 2Q22 and well above the 2-3% target range. The labour market is tight despite the higher unemployment rate to 3.5% in August from its 50-year low of 3.4% in July. To ease labour shortages, the government lifted the ceiling on permanent migration to 195k from 165k this financial year.

    Australia’s real GDP growth improved to 3.6% YoY in 2Q22 from 3.3% in 1Q22. However, the OECD does not expect the global slowdown to spare the Australian economy; it forecasts growth halving to 2% in 2023 from 4.1% this year. Fearing a global recession, Treasurer Jim Chalmers ruled out returning to a budget surplus over the next three years to the next election in 2025. Chalmers will present the Budget on 25 October after conferring with his counterparts at the G20 meetings of finance ministers and central bankers on 12 October. Chalmers is mindful of the market’s warning from UK’s mini-budget crisis to align government and central bank policy. His challenge will be to provide relief to the cost-of-living crisis with an economic dividend that does not add to inflationary pressures.

    Quote of the day
    “To succeed in life, you need three things: a wishbone, a backbone and a funny bone.”
          Reba McEntire

    4 October in history
    Dutch mathematician Christian Huygens patented the pocket watch in 1675.








    Philip Wee

    Senior FX Strategist - G3 & Asia
    philipwee@dbs.com

     

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