9 December 2025: Hassett surprises the market

Renowned City economist Gerard Lyons has told Rachel Reeves that she needs to stop fretting over fiscal headroom and worry more about levels of Government debt. It is almost as if the Chancellor has decided that she will “play the game”, but according to a different set of rules.

The UK already faces a risk premium, with a high rate of borrowing on government debt. This is explained by the stickiness of UK inflation and concern about the fiscal outlook. The latter is a worry, even after the budget.

Instead of fussing about fiscal headroom, Reeves should, instead, concentrate on the medium-term outlook for government debt. Only then will the serious state of the public finances be clear to all.

One outcome from the Budget is that the OBR decides if fiscal headroom has been met, and this determines policy rather than the other way round. Fiscal headroom is an arbitrary figure plucked from the ether by the Treasury and has no real meaning without independent verification regarding its veracity.

The short-term focus on the fiscal headroom results in taxes being seen as the primary tool to restore the buffer. In contrast, the medium-term fiscal outlook would underscore the need to control public spending to put future finances on a sounder footing. It would align policy with where financial markets are diverting their attention.

Small businesses and the man in the street are concerned about the continually rising tax burden that they face, not the amount of money Reeves has squirrelled away to guard against a rainy day.

The fiscal numbers in the Budget are not credible. A large fall in borrowing is outlined for the end of the decade, around election time. There’s little chance of that because the Government will not be interested in the size of the fiscal headroom when an election is on the horizon. There will be a clamour to increase departmental budgets to try to ensure an election victory, which, as things stand, looks highly unlikely.

A tie-up between two major oil and gas producers is expected to reduce the UK’s tax take in a blow to Rachel Reeves, the Chancellor, as companies seek to limit their exposure to government levies. This is the first of a series of events that prove that fiscal headroom is a myth in today's political and economic climate.

Yesterday, French giant TotalEnergies announced it was merging its North Sea assets with those of Aberdeen-based Neo Next Energy, in a deal to create the basin’s largest independent producer. Neo, which is backed by a private equity investor, also recently acquired the North Sea assets of Spain’s Repsol, along with BP’s former stake in the Culzean field.

Inflation is likely to return to its 2% target "in the near term" as wage growth and inflation in the services sector look set to slow further, Bank of England policymaker Alan Taylor has said. "We've got our foot on the brake a little bit still, but I see us achieving the inflation target, as we should, in the near term," Taylor said at an event hosted by management consultants McKinsey.

"Our forecast path shows that coming along next year, as both wage inflation and services inflation are continuing to come down in recent prints," he added.

The BoE's forecasts last month showed consumer price inflation, which was 3.6% in October, falling to 2.5% in the final quarter of next year and returning to target in 2027.

Taylor has regularly voted for the BoE to cut rates faster, including at November's Monetary Policy Committee meeting, where he was part of a 5-4 minority who voted for a quarter-point rate cut to 3.75%.

The pound has entered year-end mode despite two rate-setting meetings still to happen, which may see an increase in volatility.

Yesterday, Sterling lost a little ground, falling to 1.3305 and closing at 1.3325.

The Federal Reserve’s rate-setting FOMC convenes today, with a decision on any change to monetary policy to be announced tomorrow evening, London time.

There is no longer a simple dovish or hawkish background to the Fed’s decisions, since the emergence of the idea of a hawkish rate cut or a dovish rate increase, together with other variations on a similar theme. This seems to be an economist’s creation, driven by Jerome Powell’s apparent reticence to agree fully with his colleague's current dovish tendencies.

Powell is part of a diminishing cabal of FOMC members who are still not convinced that the embers of inflation will not be stoked by loosening monetary policy. There is an increasing number of voting members, primarily Fed Governors, who are “easier to get at” than Regional Fed Presidents and are influenced by the Administration's demand for rates to be cut, possibly to as low as 1%, although it recently settled at 2%.

2026 is likely to see rates move inexorably towards that level since the likely new Fed Chairman, Kevin Hassett, has that mindset. This is the main reason that he is at the top of President Trump’s list of candidates.

However, in a speech yesterday, Hassett said it would be irresponsible for the Federal Reserve to lay out a plan for where it aims to take interest rates over the next six months, emphasising the importance of following the economic data. This is the first time Hassett has said anything that varies from the Trump monetary policy doctrine.

He was asked how many more rate cuts he thought were warranted, looking into 2026. In a possible surprise to “Fed Watchers", he said, “I hate to disappoint with the counting of cuts, but I can say that what you need to do is watch the data.”

President Donald Trump earlier this year repeatedly called for the Fed to get its benchmark down below 2%, versus the current target of 3.75% to 4%. Powell and his colleagues are widely expected to take the benchmark down by 25 basis points in tomorrow's decision.

Hassett said he thought Powell had done a good job of “herding the cats at the committee” to generate a consensus behind a rate reduction this week. “I think that Chairman Powell agrees with me on this one, that we should probably continue to get the rate down some, prudently, with an eye on the data.”

Based on these comments, and not the words put in his mouth by the President, Hassett may not be the harbinger of inflation that he has been made out to be by more hawkish market analysts.

The dollar index saw a surprising amount of volatility yesterday as traders are still unsure of a rate cut. A combination of a rate cut tomorrow and Hassett’s confirmation may well lead the index into a lower start to 2026.

It fell to a low of 98.79 yesterday, but rallied strongly to reach a high of 99.23 before closing at 99.11.

The President of the European Central Bank, Christine Lagarde, spoke yesterday of the economic problems of the European Union and made it clear that the difficulties do not stem from imports into Europe, but rather from massive trade barriers within the EU’s own internal economic market.

The economic and political problems of the European Union are mainly self-inflicted, according to a speech by Christine Lagarde, President of the European Central Bank, at the 35th Frankfurt European Banking Congress.

She quantified the trade barriers within the EU’s internal market as an equivalent tariff rate of 65% for goods and 100% for services. This is the outcome of an ECB report that will be published in the next edition of the ECB Economic Bulletin.

The report, titled “What is the untapped potential of the EU Single Market?”, stresses that these “tariff equivalents” should be understood as estimated trade-policy friction losses rather than actual, politically imposed duties. They reflect a combination of political obstacles and structural or cultural factors, such as consumer preferences and differences in taste.

Lagarde sharply criticised the fact that Europe’s prosperity does not arise from its own internal market but has been built massively on exports and depends on them. Europe’s export-oriented investment behaviour confirms this. Instead of investing in its domestic economy, 10% of European equity investments (approx. €6.5 trillion) are now in U.S. stocks. This increasingly ties Europe’s prosperity to America’s economic growth.

European Central Bank Executive Board member Isabel Schnabel said she’d be willing to take over as President when Christine Lagarde’s term ends in less than two years. Schnabel would be an interesting choice and a total contrast to the likely change in Fed Chairman.

Schnabel is an inflation hawk. It is rare for her to make a speech in which she doesn’t voice her concerns about rises in consumer prices.

Asked about views that it’s time for a German to lead the ECB and whether she could be that person, Schnabel said in an interview that “if I were asked, I would stand ready.”

Current front-runners for the role are thought to include former Dutch central-bank chief Klaas Knot, Spain’s Pablo Hernandez de Cos, who currently leads the Bank for International Settlements, and Bundesbank President Joachim Nagel.

Schnabel is comfortable with investor bets that the European Central Bank’s next interest-rate move will be an increase. While borrowing costs are at levels that, barring future shocks, will be appropriate for some time, consumer spending, business investments and a jump in government outlays on defence and infrastructure will bolster the economy, Schnabel said.

“Both markets and survey participants expect that the next rate move is going to be a hike, albeit not anytime soon,” she said last week in an interview in her office in Frankfurt. “I’m rather comfortable with those expectations.”

Schnabel follows a few candidates who have “thrown their hat in the ring” Some have even received the “blessing” of their National Central Banks, such as Martins Kazaks, Governor of the Latvian Central Bank, who is considered an outsider to Knot, De Cos and Nagel.

The Euro also had a surprisingly large range yesterday, although it closed very close to where it began the day.

It traded between 1.1672 and 1.1616, closing just two pips lower on the day at 1.1638.

Have a great day!