13 October 2022: Prime Minister defies OBR

Prime Minister defies OBR

13th October: Highlights

  • Truss insists there will be no spending cuts
  • Higher rates expected to stay until inflation is defeated
  • Surprise rise in industrial production no reason for ECB to turn dovish

GBP – Public sector borrowing to hit historic level

Prime Minister Liz Truss has somehow found Theresa May’s magic money tree as she claims that there will be no cut to public spending to balance the books following the recent announcement of tax cuts. She may simply be so drunk on power that she believes that she has an unlimited mandate.

So far, the latter has been proved untrue as she has been forced to U-turn over the abolishment of the top rates of income tax, faces a rebellion over a rise in the rate of benefits and is accused of a lack of basic economic skills.

Yesterday’s announcement that there will be no reduction in public spending despite the Office for Budget Responsibility’s report of a £60 billion deficit should planned tax cuts go unfunded.

Jacob Rees-Mogg, every Labour MPs favourite pantomime villain, seems to glory in being the archetypical Tory. He was fierce in his criticism of Andrew Bailey, blaming him for the chaos in the financial markets recently.

He appears to have confused the current programme of short-term interest increases with the rises in long-term rates as the Central Bank defended the prospect of gilt fire sales.

The Conservative Party is close to disarray and the Opposition is sensing there is blood in the water and will keep the pressure on the Prime Minister until she is either forced from office or forced to make yet another U-turn.

It may even be true that the Labour Party believe that they have a better chance of winning the next General Election if the current shambles is allowed to continue.

A poll published yesterday showed that the conservatives trail Labour by 13% in ‘blue wall’ constituencies, which are considered to be strongholds. In fact, if the poll results were repeated in an election, the notion of a safe Conservative seat would cease to exist.

The Pound was shaken again yesterday by the turmoil in the markets. It fell to a low of 1.0923 against the Dollar but rallied strongly to close at 1.1101.

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USD – The danger of doing too much outweighs doing too little

The minutes of the latest FOMC minutes contained very little that the market wasn’t aware of, although perhaps President Biden would have been better served waiting for them to be released before making what is now considered an overly optimistic speech regarding the economy and the prospects of a recession.

The overarching message of the minutes was that the danger of tightening monetary policy too much is far outweighed by the risk of doing too little.

It appears that the FOMC expects to not only hike interest rates even more, but they will remain at elevated levels for longer than is expected by the markets.

One of the assets that is particularly susceptible to higher inflation, gold, is still relatively subdued. Having reached record highs earlier this year as inflation exploded higher, it has lost ground recently, which tends to point to a degree of confidence from traders that Fed action on interest rates will see inflation begin to fall.

There has been a degree of confidence generated by the release of earnings data by the largest corporations recently, but there has been little celebration as the markets prepare to brace themselves for a turbulent end to 2022 and similar start to the New Year.

At the end of the day every piece of economic data feeds into corporate balance sheets and profit and loss accounts.

If, as has been predicted, close to half a million jobs are lost in the first quarter of 2023, it will have been caused by a slowdown in sales of homes, cars, washing machines and many other items of consumer goods, that will have a direct result on sales which will drag profits lower.

For now, the odds of a damaging recession taking place are still considered 50/50 but the next few weeks will shed further light on the prospects for 2023.

The last two FOMC meetings of the year are expected to hike short-term interest rates by a total of 125 basis points, but so far that has no real context when placed against economic output and inflation.

The Dollar Index traded in subdued fashion as the market awaited release of the Fed Minutes. It ranged between 112.99 and 113.59, closing at 113.27.

EUR – Economy slowing but not radically

In some countries or regions of the world, it is left to the Administration to make overly optimistic claims of economic strength. In others, the Central Bank is left to try to bolster confidence.

It appears that the latter is true of the Eurozone.

It is hard to imagine that the President of the ECB honestly believes that the region’s economy can fail to fall into a recession early next year, if not sooner, when she has access to all the data that the market has and, probably, a great deal more besides.

In a speech she delivered yesterday, Christine Lagarde appeared to take great solace from a single strong piece of economic data to claim that the Eurozone is not in recession.

Industrial Production rose by 2.5% having fallen by the same amount in August. It is uncommon but not rare to see such a turnaround given that output has fallen so far in recent months.

She admitted that we live in a world that presents many threats and the Eurozone is far from immune, but given the energy crisis and the war in Ukraine, the Eurozone economy is performing close to target.

Lagarde has made a career, certainly during her time at the Central Bank, of seeing rainbows where none exist. If the outlook is poor, like it is now, she rejoices in current performance. And, if the current situation is poor, she looks forward to the arrival of better times.

No matter the opinion of the majority of the Governing Council, heavy storm clouds are brewing. Short of a miraculous turnaround either in Russian warlike tendencies in Ukraine or a sudden recovery in the flow of energy, it is going to be a tough winter from Helsinki to Madrid, and Paris to Vilnius.

There is a possibility that the entire Eurozone may not be forced into announcing a recession in 2023 despite the economies of France, Germany, Spain and Italy all seeing a contraction in Growth.

However, a fall of 2% in German GDP is probably equivalent to 5% growth in some small economies, so even in economics certain things are relative.

The Euro fell to a low of 0.9668 yesterday but managed to attract sufficient buying interest to close at 0.9702.

Have a great day!

Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.