Europe rallies as UK U-turns settle nerves

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By Marc Jones

LONDON (Reuters) - Europe's shares, bonds and major currencies rallied on Monday, helped by relief that's Britain new finance minister had quickly shredded virtually all of the unfunded tax cuts that triggered UK market turmoil this month.

Asia's main bourses had struggled overnight but Europe's STOXX 600 made 0.6% and Wall Street futures were up over 1% as the pound and UK government bonds soared in London.

Britain's new finance minister Jeremy Hunt announced he was reversing "almost all" the tax measures laid out by Prime Minister Liz Truss and his predecessor Kwasi Kwarteng just three weeks ago.

Bank of England Governor Andrew Bailey gave Hunt a vote of confidence on Saturday, saying they had an "immediate meeting of minds" on the need to fix the public finances, where there are estimates of a 70 billion pound ($78.72 billion) black hole.

Hunt said in his statement that it was "not right to borrow to fund these tax cuts" and that his measures would bring in over 30 billion pounds. Saxo bank's head of FX strategy John Hardy said Britain's issues would remain a key focus though.

"It is a bid for stability in sterling and the UK bond markets that goes in the right direction," Hardy said, pointing to the rally in the pound against both the dollar and the euro as a thumbs-up from the market for Hunt's moves.

"But I think we have probably gone as far as we can with the sterling move ... We still have nothing to address the UK's structural issues that drove the weakness in the first place - a massive yawning twin deficit that still needs to be financed."

The reactionary rally though saw yields on British 10-year gilts fall 34 bps to 3.97%, while those on the 30-year dropped 38 bps to 3.78%.. Yields reflect borrowings costs and move inverse to a bond's price.

Other European markets benefited too, including the German 10-year Bund yield which moved down to 2.245% having hit 2.423% last week, its highest since August 2011.

That was also despite two key ECB policymakers making the case over the weekend for cutting the bank's balance sheet and after U.S. inflation data on Friday had bolstered bets on another aggressive rate hike from the Federal Reserve next month.

ROTATING

Overnight, MSCI's broadest index of Asia-Pacific shares outside Japan eased 0.6% and back toward last week's 2-1/2 year low.

Japan's Nikkei shed 1.2% and although Chinese blue chips rose 0.4% there was uncertainty as Beijing took the unusual step of delaying the release of economic indicators, including its third-quarter gross domestic product data due on Tuesday.

The delay comes amid the week-long congress of the ruling Communist Party, a twice-a-decade event that is an especially sensitive time in China and where President Xi Jinping is widely expected to win a precedent-breaking third leadership term.

S&P 500 futures meanwhile were up over 1% amid the rally in Europe and after a sharp Wall Street retreat on Friday.

While the S&P is an eye-watering 25% off its peak, BofA economist Jared Woodard warned the slide was not over given the world was transitioning from two decades of 2% inflation to a time of something more like 5% inflation.

"$70 trillion of 'new' tech, growth, and government bond assets priced for a 2% world are vulnerable to these secular shifts as 'old' industries like energy and materials surge, reversing decades of under-investment," he wrote in a note.

"Rotating out of 60/40 proxies and buying what is scarce - power, food, energy - is the best way for investors to diversify."

INTERVENTION WATCH

A red-hot U.S. consumer price report and rising inflation expectations have markets fully expecting the Federal Reserve to hike rates by 75 basis points next month, and likely by the same again in December.

A host of Fed policymakers are speaking this week, so there will be plenty of opportunity for hawkish headlines. The earnings season also continues with Tesla (NASDAQ:TSLA), Netflix (NASDAQ:NFLX) and Johnson & Johnson (NYSE:JNJ) reporting, among others.

Analysts now expect profit for S&P 500 companies to have risen just 3.6% from a year ago, much lower than an 11.1% increase expected at the start of July, according to Refinitiv IBES data.

Goldman Sachs (NYSE:GS) also reports this week and the Wall Street Journal reported the investment bank plans to restructure its biggest businesses.

In China, the congress is expected to grant a third term to Xi, while there could be a reshuffle of top economic roles as incumbents are near retirement age or term-limits.

"Investors haven't fully digested that China isn't going to be a high growth economy any more," said Janus Henderson Emerging Markets Portfolio Manager Ales Koutny who also expects the yuan to keep falling. "It is not going to be 5%-6% growth a year, it's going to be 2%-3%."

In currency markets, the dollar remains king as investors price in U.S. rates peaking around 5%.

The yen has been particularly hard hit as the Bank of Japan sticks to its super-easy policy, while authorities refrained from intervention last week even as the dollar sped past the 148.00 level to 32-year peaks.

Early on Monday, the dollar was up at 148.76 yen and heading for the next target at 150.00.

The euro was holding at $0.9733, having put in a steadier performance last week, while the U.S. dollar index eased a fraction to 113.20.

The rise of the dollar and global bond yields have been a drag for gold, which was stuck at $1,648 an ounce.

Oil prices were trying to bounce, after sinking more than 6% last week as fears of a demand slowdown outweighed OPEC's plans to cut output.

Brent firmed 90 cents to $92.55 a barrel, while U.S. crude rose 84 cents to $86.45 per barrel.