Markets were already enduring a torrid time when the British government dropped its fiscal bomb on Friday. Earlier in the week, the US Federal Reserve had raised rates by 0.75% as expected, but there was no let-up in the hawkish tone as the Fed simultaneously cut its growth forecast and lifted its own expectations for future interest rates. Once again, the Fed is signalling that it is ready to tolerate a recession in order to combat inflation. This has been the message for a while, but markets are now repricing how far the Fed will go, and how deep any recession might be.

Attention then switched to the strength of the US dollar in what is now being termed a currency crisis. Having seen the yen fall 20% against the dollar since the start of the year, Japan’s central bank was forced to intervene to support its currency for the first time since 1998, producing an immediate gain of 2.3% on the yen-dollar exchange rate. Commentators were sceptical, however, whether even the vast reserves of the Bank of Japan would be enough to win this battle, and the yen subsequently fell back over the course of the week. The People’s Bank of China was simultaneously conducting its own war against speculators, which culminated in the imposition of stricter currency exchange controls. The Chinese yuan is flirting with its lowest level against the dollar since 2008, prompting fears of capital flight. The pound was already under pressure against the US dollar, having fallen to $1.12, when the Bank of England announced its decision to raise rates by another 0.5%, though some had been anticipating a 0.75% rise to keep pace with the Fed and European Central Bank.

The publication of highly-anticipated European business activity surveys on Friday morning confirmed fears of another step-down in economic activity, with both the UK and Eurozone showing signs of outright economic contraction. It was into this maelstrom that the British Chancellor announced a radical change in policy towards unfettered government spending in a seemingly desperate attempt to stimulate economic growth, prompting an immediate collapse in sterling and UK government bond markets. It didn’t help that the Chancellor shrugged off the move in markets with the phrase, “The markets will do what they will do”, perhaps forgetting that government bond yields dictate the cost of government spending and that the level of sterling contributes to inflation via the cost of imports. Sterling fell by over 3% against the dollar on the day of the news and a flash-crash in overnight trading in Asia on Monday sent it down another 4% to, momentarily, $1.04. The pound subsequently recovered from that debacle but is still trading at a record low to the dollar. UK government bond yields jumped to their highest in a decade, anticipating massive additional government expenditure, the increased cost of funding that expenditure and the possibility that the Bank of England may have to raise rates to prevent further depreciation of the pound. Stock markets are often the beneficiaries of lower taxes and higher government spending, but scepticism is currently so rife even amongst equity investors that the UK-orientated FTSE 250 stock market index ended the day at new lows for the year.

The repercussions went far wider than UK assets, however, as global investors reconsidered how likely their own governments would be to spend their way out of trouble. Bond yields all over the world surged and global stock markets tumbled, with US and European markets also reaching new lows for the year. 

Ford Motor Co. had its biggest daily decline in value in eleven years, with its shares dropping by 12%, after the company reported $1 billion of extra costs due to inflation in the current calendar quarter. Moreover, shortages of parts continue to plague the company’s productivity. Perhaps optimistically, management maintained its full year forecast for profits.

Shares in the British retail chain JD Sports Fashion were also given short shrift despite its management also sticking to profit guidance for the full year. Investors were more focused on the short-term problems of softer demand, supply chain-inflation and strikes at two ports (Felixstowe and Liverpool) used by the company to receive imported products. The shares fell 17% over the week.

In a rare piece of good news from the European banking sector, Italian banking giant UniCredit announced that it will “substantially upgrade” its guidance for profits in the coming quarter. The group’s Chief Executive pointed to the unexpectedly sharp rate rises by the European Central Bank, which took interest rates into positive territory, as being a key driver. The shares rose 5% on the day. Germany’s Deutsche Bank issued a similarly positive update, stating that improved income from loans would more than offset any effects of the inflation crisis. There was no such luck for Credit Suisse, however, as the bank’s share price fell to a record low on rumours that it would be pulling out of its American activities entirely.

The energy sector was the worst performer of any industry on Friday, falling by 5-6% across the board, as investors took fright at the recent decline in the oil price and the outlook for global demand. Being denominated in US dollars, the strength of the dollar has added to the pressure on oil consumers overseas. 

• The US Federal Reserve raised rates by 0.75% as expected. The real interest was in the bank’s new economic forecasts, however. The Fed slashed its forecast for 2022 economic growth from 1.7% to just 0.2% and raised its estimates for inflation and unemployment.
• The Bank of England raised rates by another 0.5% at its meeting on Thursday, though some had been anticipating a bigger rise to keep pace with the Fed and the European Central Bank. Separately, the bank approved plans for an £80 billion reduction in its holdings of government bonds, which may now be derailed by the mini-budget.
• Business activity surveys for early September showed clear declines in both services and manufacturing sectors in the Eurozone, while plummeting service sector activity in the UK also pointed towards a recession. US activity, on the other hand, rebounded markedly. 

• Inflation in the Eurozone is expected to have risen to 9.7% in September from 9.1% last month, with the core rate (excluding food and fuel prices) rising to 4.7% from 4.3%. Germany is likely to have been the main driver of higher prices, with the other major Eurozone nations being flat or down.
• Chinese business activity surveys are expected to show a slight pick-up in activity, as energy disruptions fade. But this is likely to be offset by a deterioration in demand for Chinese goods from the rest of the world.
• With a sterling crisis ongoing, the UK balance of payments will be scrutinised for any potential impact on currency flows. The current account deficit is expected to have declined to £43 billion in the second calendar quarter from £52 billion previously.