21 December 2023: Sunak sees an increase in growth and dynamism in the coming months

The reaction to yesterday’s publication of the latest data for inflation was surprising. Just about every person who owns a petrol-driven vehicle will have noticed a significant fall in the price of petrol over the past six weeks, so it would have been a far greater surprise if headline inflation hadn’t fallen.

Headline consumer prices fell to 3.9% from 4.6% last month, while core prices with volatile items like energy and food stripped out also fell, from 5.7% to 5.1%.

With inflation in both the Eurozone and the U.S. significantly lower than in the UK, consumers are often puzzled, given that interest rates have been rising in this country for longer than in our G7 partners, why inflation in the UK is still higher than either in mainland Europe or on the other side of the Atlantic.

While it is easy to blame Brexit, the reason predates any economic union in Europe and is perfectly simple. The UK, being a relatively small island, has to import a far larger percentage of its consumption.

In 2020, the last time that comprehensive data was published, 46% of the country’s food was imported. A trip to any supermarket proves the point, with Spanish tomatoes and Dutch peppers, for example, readily available and cheaper than home-grown varieties.

Yesterday’s data brought the discussion about rate cuts in the UK into sharper focus.

Sarah Breedon, a Deputy Governor at the Bank of England and the newest member of the Monetary Policy Committee spoke earlier this week of the need for rates to stay “higher for longer”.

Her speech will have been rooted in the basic and normal concerns presented by the relative fragility of supply chains. However, the easing of restrictions on exploration for oil in the North Sea will most likely ease concerns in the coming years.

The Prime Minister hosted the CEOs of some of the UK’s largest companies yesterday, as he held the year’s final meeting of his Business Council.

He told the heads of Barclays Bank, Aviva, and GSK, among others, that the latest inflation data allows the nation to see more economic growth and dynamism in 2024. He believes that an era of “firefighting” is ending, and the government can look forward to being able to promote a significant improvement in living standards. This improvement is likely to include the tax cuts expected to be announced in the Spring.

The pound has entered Holiday mode now, with a significant fall in liquidity being seen.

Yesterday, the Sterling saw a negative reaction to the inflation data, which led traders, who are still interested in trading, to believe that rate cuts could be on the agenda despite the views of the MPC.

It fell to a low of 1.2626 and closed at that level.

This week’s publication of durable goods orders for November is expected to show a significant turnaround from October’s data, with a rise of 2.2% following a fall of 5.4% previously.

Although this data is notoriously volatile since it deals with orders for “big-ticket” items like ships and planes, it shows that, in the long term, the economy is gaining strength.

Austen Goolsbee, President of the Chicago Fed, has become a frequent and vocal commentator on the attitudes of the Federal Reserve, presumably with the consent of Jerome Powell.

He spoke yesterday of his surprise at the market’s attitude to Powell’s comments following the latest FOMC meeting.

Powell confirmed the worst kept secret in global financial markets, that the Fed had likely ended its cycle of rate hikes, and updated its projections for 2024, which included three rate cuts during the year.

It seems that it’s “not what the chairman says, but what the market hears” which drives stocks, bonds and the currency”, Goolsbee said.

He pushed back against the idea that the Fed is actively discussing a series of rate cuts. “We don’t debate specific policies, speculatively, about the future. We vote on that meeting,” he said.

The market is expecting the Fed funds rate at the end of 2024 to be between 3.75% and 4%. That would mean a maximum of six twenty-five-point cuts or three fifty-point cuts during the year.

The Fed is not expecting to be in a position where fifty-point cuts are necessary, since that would convey a level of concern about the economy that the Fed, at this time, it doesn’t feel.

Goolsbee was not the only Fed President to downplay the significance of Powell’s comments. John Williams, the President of the New York Fed, commented recently that the FOMC “isn’t talking about rate cuts at present”.

The dollar index appears to have found the bottom of its recent correction, despite the lack of liquidity that is currently present.

The Greenback rallied to a high of 102.54 yesterday and closed at 102.48 as its range continued to shrink.

The latest data for inflation is adding to speculation that the ECB may have “overcooked” the number of rate hikes that it enacted before it finally drew its cycle of increases to a close.

There was a strong expectation that the Governing Council would end rate hikes when its members returned from their August holidays, but looking back there were no official comments about hikes concluding other than the “wishful thinking” of those members which had been dovish for some time or been recently recruited to the cause.

While the Italian, Spanish and Portuguese Central Banks had felt “squeezed” by the continual hiking of rates, it was the comments from the Dutch and Belgian Central Bank Presidents that made the market believe that an end was imminent.

Likely, the majority in favour of further hikes diminished quite dramatically at the September meeting, which paved the way for the end of the cycle.

With hindsight, although it is doubtful that Christine Lagarde would agree, a pause would have been better announced at the 2nd of August meeting.

If that had been the case, the authorities would have had two months to study the effect on confidence and still had an opportunity to resume rate hikes if it was deemed necessary.

Lagarde burned her bridges largely by insisting that there would be no pause, and when the hikes were ended it would be because the Governing Council felt that rates had become sufficiently restrictive to drive inflation back close to its 2% target.

European Union Finance Ministers announced a series of changes to fiscal rules at their latest meeting this week.

They reiterated the importance of the Growth and Stability Pact and said the new rules would offer tailor-made debt reduction paths and incentives to invest, although they didn’t set out exactly what the new rules would be and whether they would have “teeth”.

Ignoring the earlier rules caused the Greek debt crisis and almost brought down the entire Eurozone.

The Euro drifted further away from the resistance at 1.0980 yesterday as the market lacked direction.

It fell to a low of 1.0931 and closed at that level.

Have a great day!