Our research

Lagarde set to hike again before her departure

UK Budget: Boat-rocking averted

Yesterday’s Budget announcement was broadly in line with the expectations we laid out in our preview on Monday (see UK Budget: Don’t rock the boat). Our growth, inflation, and interest rate forecasts are unchanged. We still expect the Bank of England to hike rates at the November and February meetings. The key test was to remain credibly committed to the fiscal rules given nervous bond markets. On this measure, the UK government passed, with a muted reaction in gilt markets. Although headroom against meeting the government’s fiscal rules did decline, this was the first Budget at which the rules were tested over a more strict three year horizon (a change that previous Chancellor Rachel Reeves put into place in 2024). The government came with some piecemeal cost-of-living measures that were to a significant extent funded by targeted tax rises (see below). These will alleviate some of the pain from high energy prices, but won’t move the macro needle in our view. Perhaps the biggest surprise was the more solid commitment to meeting the 3% GDP defence spending target in 2030. This relies partly on as yet unspecified departmental capital spending cuts, and we think this will be challenging for the government to meet. The government is probably hoping that growth and revenues eventually outperform the OBR forecast. As we explained in our preview, this is not entirely unreasonable given the OBR’s very cautious wage growth assumptions (which saw only modest changes this round). Still, while the UK economy has been surprisingly resilient this year, and our base case sees that resilience continuing, such a pathway is not without risks given the elevated risk of shocks to the global economy in this volatile geopolitical environment.

FOMC Watch - Rates on hold, rate-setting meetings cut

The Fed's FOMC kept the target range for the federal funds rate at 3.75-4.00%. Hammack and Cook dissented in favour of a hike. Two other potential dissenters, Logan and Kashkari, chose not to dissent, possibly because they expect a hike in December. The committee gave no clear signal of a December hike, but kept the option open. The post-meeting statement was marginally longer than usual. It added: ‘The accumulation of more information will help the committee determine the policy stance appropriate to ensure a timely return of inflation to the committee’s 2% goal.’ This appeared to satisfy markets as an explanation for today’s inaction.

Top of Mind - AI capex boom to die another day

A troika of capex booms – AI, defence and clean energy – is set to reach USD 3.5 trillion this year across the US, Europe and China. The main growth impulse is coming from AI capex, which is growing rapidly, but signs are that the pace will slow in 2027. If AI capex is in line with guidance, the growth impulse will not fall off too much and will be more than offset by higher US defence investment. US capex will therefore remain strong but the spillovers to other economies will likely be less, while EU and China capex will slow. We do not expect an AI capex bust in the near term, but the economics do not bode well for the medium term: It will probably die another day.

FOMC Watch – Patience, not complacency

We expect the Fed to hold on Wednesday, with some risk of hawkish dissents. Inflation remains too hot, but declining breadth and a cooler labour market give the Fed room to wait. Markets have sharply reduced the probability of an October hike, and December is no longer fully priced. We still expect one final 25bp hike in December, followed by an extended hold.

UK Budget: Don’t rock the boat

Newly appointed Chancellor of the Exchequer, John Healey, is unlikely to rock the boat when he delivers his first budget this Wednesday. Rising debt-servicing costs, with Gilt yields near multi-decade highs, are eroding the Chancellor’s fiscal headroom… but the UK’s high inflation means wage growth is likely to be a crucial offset, making room for a potential positive surprise. We expect the Chancellor to prioritise rebuilding fiscal headroom, while balancing targeted tax rises with limited cost-of-living support. Our base case sees Healey erring on the upper end of credible headroom estimates of around £18-24bn. Below £14bn, the Chancellor risks a negative bond market reaction. Headroom above £24bn is likely to result in a positive market reaction. Macro & rates implications likely limited: we expect solid growth, elevated inflation, and two BoE hikes over the coming months.

ECB rescue for bond markets remains distant

French government bond spreads hit a 15 year high yesterday. Still, ECB intervention in French bonds remains unlikely. Current market stress does not appear to threaten monetary-policy transmission or materially tighten liquidity conditions… and spread widening largely reflects France-specific risks. Contagion remains limited, with moves elsewhere largely reflecting country-specific fundamentals. TPI eligibility complicates, but does not preclude, intervention in France, as the ECB retains discretion in applying the framework. Stopping QT would require evidence that balance-sheet runoff itself was impairing transmission or disorderly market conditions… while skewed reinvestments would require additional evidence of country-specific stress impairing monetary-policy transmission. Tighter financial conditions could influence the ECB’s broader monetary-policy deliberations even without direct intervention. Intervention depends not on a specific spread level, but on the extent of spread divergence, speed and volatility, and contagion to other markets. Market pressure supports fiscal discipline, while political demands are more likely to reinforce ECB independence.

FX Weekly - Euro under pressure

The euro has weakened since September, especially against the yen, US dollar and Norwegian krone. Wider interest rate spreads favour US dollar and sterling over the euro. Fiscal and political concerns in France, together with high energy prices, have added pressure on the euro. We expect the euro to recover against the US dollar and sterling as current market expectations adjust.

Top of Mind - Optimism and worry in Bangkok

I spent the last week at the Annual Meetings of the IMF and World Bank in Bangkok attending a wide variety of meetings. The ability of the global economy to withstand shocks was a key theme of the meetings, and most expected this to continue. Worries about the risks remained, from the sustainability of the AI capex cycle, to geopolitics, rising interest rates and sovereign debt. AI capex would remain strong, but there was a general agreement that the scale of capex did not justify the revenues that would be generated. Although flagged as a risk, geopolitics may now be an underrated one and turn out to be ‘the boy who cried wolf’. Most saw the rise in bond yields as being the markets re-evaluating r* but there was lively debate on this topic. France was seen as the major sovereign risk, though the degree of concern varied, while it was agreed that interventions were unlikely.

China: Growth improves, imbalances remain

Real GDP growth picks up moderately in Q3, in line with our forecast. September data confirm pick-up of growth momentum during summer. Supply-demand imbalances do not show signs of easing.