Markets caution in the shadow of political tensions, UK inflation at new record high

The early European trading session was dominated by political events, following a light economic calendar. As Western officials attempted to avoid escalating tensions with Russia, the US dollar weakened in early European trade Wednesday, giving back overnight gains It is also worth noting that European stocks opened on Wednesday marginally lower. Mercedes Benz Group led losses in automaker stocks, while a blast in Poland kept sentiment subdued and contributed to a rise in defence stocks.

The latest shocking news was the fact that inflation in the UK surged to a 41-year high of 11.1% in October, which exceeded expectations, as food, transportation, and energy prices continued to hit households and businesses severely.

According to economists polled, the consumer price index had been expected to increase by 10.7%, up from a 40-year high of 10.1% seen in September.

While the government introduced the Energy Price Guarantee program, the Office for National Statistics reported that electricity, gas, and other fuels contributed the most upward pressure. The rise in core prices is also becoming a larger concern, despite the stabilization of energy prices over the past few months. The Bank of England is going to announce another 75 basis points hike this month. This is in hopes the core annual CPI won't climb much higher than the 6.5% we saw in October after raising rates by 75bps last month.

As part of its upcoming fiscal plans set to be unveiled tomorrow, the new UK government may also help slow down the inflation rate. Several new tax hikes and spending cuts are expected to be announced as part of these plans. The most effective way to slow inflation is to kill demand, and that is exactly what the government's updated plans look to do. In terms of historical comparisons, wages have held up relatively well, but they remain well below headline inflation levels, which has kept consumer spending contained.

In addition, the PPI inflation rate is showing signs of slowing, and it is expected to continue to do so in the coming months, which could result in lower inflation levels in 2023.

Although retail sales have been uniformly dreadful this year in the UK, consumers in the US have reacted more resolutely to price pressures despite similar price pressures, though the spike in natural gas prices we have seen in the US has been nothing compared to those in the UK and Europe.

There was some selling of the dollar on Tuesday afternoon, following the release of a weaker-than-expected rise in producer prices, which contributed to a decrease in consumer inflation that was also reported last week, suggesting that the Federal Reserve's aggressive rate-hike drive could be nearing its end.

Even though it still seems too early to predict the dollar will get back to its peak by the end of 1Q23, we do not expect sustained weakness in the US dollar as the Fed would need to see signs that the labour market is cooling before deciding to pivot to a more dovish stance. However, recent data has shown that the economy is still growing, unemployment is low, and wages are rising fast. Retail sales in September were unchanged from the month before, while the previous month's numbers were revised up by 0.4%.

It is expected that today's October numbers will come in at 1%, which suggests that despite rising prices, consumers still have the appetite to spend money, even in the face of rising gas prices.