19 December 2023: Could it be that Brexit was a correct decision?

Since the UK voted to leave the European Union, its economy has been struck by two noteworthy events from which it has recovered moderately well, despite the way they were managed by the Government and possibly to a lesser extent, the Bank of England.

If it were possible to put aside the crass and cavalier behaviour of Boris Johnson’s Government and the human cost of the Pandemic, the handling of the economic effect was reasonable, given it was a giant leap into the unknown.

The level of support that was offered to small businesses and the self-employed is now leading to a significant rise in liquidations and bankruptcies as they struggle to repay emergency loans. It is impossible to quantify just how many businesses would have gone under had the support not been made available, but the number would likely have been far higher than is currently the case.

It is moot whether the effect of Brexit was a factor in the Government’s response. However, at the time it was clear that the European Commission didn’t cover itself with glory in its reaction to production and delivery of the vaccine.

As politician turned game-show contestant Nigel Farage said recently, “of course mistakes were made, but they were the UK’s mistakes to make and were not foisted upon the country by Brussels”.

The rise in inflation following the end of the Pandemic should have been far more easily predicted, given the resources that were available at the time to the Bank of England.

Even though it was the first G7 Central Bank to begin to raise interest rates, Andrew Bailey and his colleagues on the Monetary Policy Committee always appeared reticent and wary of making the necessary bold decisions.

The Russian invasion of Ukraine and latterly the war between Israel and Hamas has had a substantial effect on the global economy.

This has exacerbated the demand issue which the economies of Europe and the UK have faced but, again, the “morbid fascination” that the ECB has with inflation has led them to overcompensate, first by waiting too long to hike rates, and then continuing its cycle of rate hikes for longer than was necessary.

It is generally believed that the first half of 2024 will see the UK avoid a recession, while the Eurozone may already be suffering from a contraction of growth, activity, and output.

The upshot of this period is that, of course, the UK made mistakes over the past two or three years, but the situation could have been a lot worse. As the country and its economy enters a new era with the likely election of a new Government, which will also no doubt make mistakes, but will have the backing of the majority of the population.

The pound experienced further mild selling interest yesterday as the events of last week were put into perspective. Sterling fell to a low of 1.2628 and closed at 1.2646 as the dollar bounced off medium-term support.

The U.S. economy is apparently on the verge of a golden period of low unemployment, low inflation and a level of growth that will be eyed with envy by most of the developed world.

That is the view as seen through the eyes of President Biden, who will stand for re-election in under a year’s time, most likely facing his nemesis, Donald Trump.

On the ground, the situation is not massively different to the rose-coloured view of the President, but there are still concerns that the Fed may still need to hike rates in the new year as the level of new jobs being created has not yet fallen to levels considered to be appropriate at this point in the economic cycle.

It has been a tough lesson to learn, but there is undoubtedly a new economic paradigm within the economy that was started by the Pandemic. The rise in technological advances, over what has been an incredibly short period, has had a significant effect.

AI, which is still considered science fiction in several areas, has been the “undercover” success story of 2023 and has led the economy to a level of growth that was unimaginable earlier in the year.

It was assumed that, with interest rates rising from close to zero to 5.50% in a little over a year, it would tip the economy into recession even if it did solve the inflation issue.

Jerome Powell dragged the FOMC with him in concluding that rates had to rise quickly to have the desired effect on inflation without a recession being the ultimate result.

He has been helped by employment data which has been extraordinary, with every month economists expecting the bubble to burst. The latest figures show that the economy added 199k new jobs, following the addition of 180k in October, while inflation is falling at a gradual pace.

It does feel like the Fed has found the correct level for interest rates which cools demand sufficiently for inflation to fall, but still allows businesses to expand and invest.

The advent of the Goldilocks scenario may still fail to materialize, but fewer commentators are not predicting a soft landing for the U.S. economy as we enter 2024.

The dollar index has seemingly recovered from the reaction to Jerome Powell confirming that rate hikes are most likely to have come to an end.

Yesterday, it consolidated its gains from Friday, reaching a high of 102.66 and closing marginally lower at 102.50.

The ECB is still worried about inflation. That is no surprise to anyone familiar with the comments that have been made over the second half of this year by several Central Bank Governors. To the outside world, the balance of risks to the Eurozone economy is skewed towards falling growth rather than rising inflation.

The ECB has had a tough year. It was late in beginning its cycle of interest rate hikes, as several of the region’s weaker economies were considered too fragile to deal with higher interest rates.

Eventually, when rates were hiked, they started very aggressively hiking by seventy-five basis points three times and by fifty twice, but in May of this year, they inexplicably lowered the increments to twenty-five basis points.

History may show that had they persisted with the larger hikes for possibly two more meetings, three at the most, they would have been able to call a halt in August as the market had expected.

It is obvious that the unwieldy nature of the Bank’s Governing Council where the six members of the Executive Board and the heads of the Eurozone’s twenty members each vote on changes to interest rates has two effects; first it makes the entire process cumbersome, and it also allows self-interest to play a significant part.

Christine Lagarde was forthright in her comments that there would be no pause in interest rate hikes, and when the ECB ended its cycle, it would be because the Council felt that rates had reached a level at which they would restrict demand and see inflation fall.

Inflation has fallen since the end of the cycle of hikes, possibly by more than Lagarde expected, but since it has now plateaued, any thought of rate cuts to assist a clearly ailing economy has been pushed even further into the future.

Two members of the Executive Board made speeches yesterday. Hawkish German member, Isabel Schnabel confirmed her belief that rates should remain unchanged until at least mid-2024. Philip Lane, the ECB’s Chief Economist, commented that the fall in inflation is welcome, but progress must continue to be made.

It sums up the mood perfectly that the hawk made a dovish comment, while the perceived dove was more hawkish.

The euro recovered slightly from its fall on Friday but is unlikely to challenge the 1.10 level again before the Holiday unless there is a significant and unforeseen event.

Yesterday, it rose to a high of 1.0931 and closed at 1.0919.

Have a great day!