17 October 2023: The UK is in a “difficult position”

The Chancellor of the Exchequer, Jeremy Hunt, is working on his Autumn Statement that will be delivered to Parliament next month. It is becoming increasingly certain that any thought of tax cuts can no longer be considered while further cuts in public spending remain a real possibility.

This is not the position that the Government expected to find itself in as it prepares to fight a general election that will be contested against a backdrop of almost zero growth and persistently high inflation.

The Bank of England is fighting a losing battle to bring inflation down close to its target of 2%, and it is looking unlikely that the halving of the rate of inflation that Rishi Sunak promised when he became Prime Minister is unlikely to be achieved.

The Bank of England will not be able to begin lowering interest rates until the second half of 2024 according to a report published yesterday by the influential think tank, the Institute for Fiscal Studies (IFS).

The continuation of high interest rates is likely to lead to a recession early next year, although it is impossible to say how deep the contraction will be.

Jeremy Hunt’s warning that the state of public finances precludes any tax cuts before the Spring was confirmed by the IFS which also said that its prediction that the Public Sector Borrowing Requirement (PSBR) would be twenty billion pounds lower this year than last has been overtaken by soaring debt levels and continued high and rising interest rates.

There was better news for mortgage payers as building societies and other lenders have seen demand for home loans grow as the market has stabilized as lenders are able to offer two and five-year mortgages at more competitive rates.

Citibank has also predicted that the UK economy will contract next year, but it has been prepared to say that any recession will see the economy contract by around 0.75%.

The failure to stimulate growth post-Brexit and the country’s elevated level of debt mean that public spending on items like NHS waiting lists won’t be achieved before the election.

Today’s employment report will show that average earnings are still well above the headline rate of inflation, at 7.8% and are not falling materially as was considered likely.

The pound is still suffering from the fall in risk appetite due to the escalation in global tensions, although it did manage to rally yesterday. It climbed to a high of 1.2219 and closed at 1.2211, but any upside potential looks to be severely limited.

Just when it looked like Jerome Powell was going to be able to achieve the difficult task of a soft landing for the U.S. economy, the country will have to face the fallout to the global economy of two wars as the situation in Ukraine shows no signs of improvement and trying to contain the fallout from the expected fallout of a ground invasion by Israel of Gaza will prove to be more difficult.

China continues to bide its time in the global context allowing the U.S. to consider itself the peacemaker, although it heavily favours the Israeli side for now.

That may change if global opinion is affected by the continued bombing of civilian targets in Gaza with no seeming endgame. A humanitarian crisis in Gaza now looks unavoidable as Israel continues to try to drive the Palestinian population south.

President Biden is expected to visit Israel today to receive a first-hand report on Israel’s intentions from Prime Minister Netanyahu.

Domestically, despite the falls reported recently in inflation, the Fed is still grappling with monetary policy. Another rate hike is considered unlikely at the next FOMC meeting which means that there will be just one meeting left this year at which a hike could take place and Powell is unlikely to want to go into 2024 with the Fed still in a tightening bias.

Globally inflation is still elevated, a situation that was not expected to prevail earlier in the year as G7 Central Banks were all expected to have ended their programmes of rate hikes by the end of Q3.

A further problem that could affect the soft landing is the continued strikes that are continuing in the auto sector. Deliveries of new vehicles are now being hampered and yesterday the Chairman of Ford, Henry Ford’s great-grandson, Bill Ford, called for an end to a dispute that has become “extremely damaging for his company, the auto sector and the economy in general.

The headwinds that are gathering for the economy may lead the Fed to be the first G7 member to cut interest rates, but that will not happen until the headline rate of inflation has fallen below 3%.

The currency market has been less volatile than it has for several years as Central Banks have tightened monetary policy and drained excess liquidity that was pumped in during the Pandemic and subsequent support measures.

This will probably remain since there is a global perspective to most of the factors that are currently drinking the markets.

The dollar index paused for breath yesterday as the market awaited news of Israeli intentions in Gaza. It fell to a low of 106.18 but is still in a short-term uptrend as risk aversion remains intact. It closed adjacent to its low for the day at 106.20.

The continued fight against inflation is not causing the fall in consumer confidence that would have been considered likely given the length of time that the cycle of rate hikes has continued.

Retail sales figures have been severely hit, but that is more to do with shortages of many items, especially foodstuffs, than a lack of confidence.

The population of the Eurozone have been extraordinarily patient in their acceptance of higher rates. This has led to the feeling that the people, particularly those in the north of the region, understand that rates needed to rise given the effect that low rates were having on savings rates and pension pots.

Ireland, which suffered severe inflation, particularly in its property sector, has exercised significant restraint over the past eighteen months that has allowed its economy to flourish as one of the strongest in the region.

Yesterday Spain, which was recently hailed as having the strongest economy in the region, released figures that showed it is the first to see inflation below 2%.

While these and other stories show the resilience of various states, there are still structural issues that need to be resolved that may not be able to wait until the current situation resolves itself.

Long-term rates are continuing to rise, and the withdrawal of the support of the ECB which is trying to reduce the size of its balance sheet is causing genuine issues to some nations, Italy, in particular. The hardline that is being taken over the falling price of Italian Government debt will be unhelpful in the long-term.

Another debt crisis is being risked and that would see political pressures rise.

The Italian Prime Minister Giorgia Meloni has been extremely patient of late, carefully considering her criticisms of Brussels and Frankfurt. However, any fall in her approval rating may reignite her Party’s radical right-wing views which could threaten the very existence of the Union.

The European Union appears to be constantly on a knife edge. That is due to the high levels of bureaucracy in Brussels and weak leadership. It will be virtually impossible to agree fiscal union in the current climate but until that is achieved, the ECB will be faced with deciding monetary policy that is only 75% effective at best.

In these conditions any meaningful growth will be tough to achieve, and ECB President Christine Lagarde has virtually ruled out any cut in rates before July of next year.

The euro staged a minor comeback from its recent lows yesterday. It reached a high of 1.0562 and closed at 1.0560.

Have a great day!