27 May 2022: Sunak announces 25% windfall tax

Sunak announces 25% windfall tax

27th May: Highlights

  • Chancellor announces cost of living support
  • Retailers feeling the squeeze from inflation
  • Concern growing of fresh debt crisis

Government in abrupt U-Turn

The Government announced yesterday that it would introduce a package of measures to help with the cost-of-living crisis that is threatening to engulf the economy.

Chancellor Rishi Sunak announced that every household will receive a £400 payment to contribute towards their energy bill. That is replacing the £200 payment that had already been announced. Furthermore, the £400 will not need to be repaid over five years as the £200 payment had been.

Eight million of the lowest income families will receive a one-off payment of £650. Additionally, the disabled will receive a payment of £150. This means that the worst-off households will benefit from these measures to the tune of £1,200.

Having seen the Chairman of Ofgem, the fuel and energy regulator, announce this week that the energy cap will rise by a further £800 in the Autumn, these measures have been welcomed by all sides of the House of Commons.

The additional payments that will total approximately £15 billion will be partly funded by an additional levy on the profits of energy companies. That will amount to £5 billion. The Chancellor refused to call it a windfall tax when interviewed following the announcement.

This was most likely due to the fact that the Government had only last week ruled out the introduction of a windfall tax, since it believed it was bad for investment.

Recently the Leader of the House of Commons Jacob Rees-Mogg confirmed the feelings of the majority of Government MPs that all such taxes return in some way to the public. In this case, a tax will see dividends cut which will affect pension funds which invest significant sums in this sector.

The energy companies themselves condemned the new levy, commenting that it would reduce investment in cleaner energy and several green projects.

Next week will be shortened by the two-day public holiday in the UK for the Queen’s platinum jubilee. There are no significant data releases, so it is likely that the pound will return to reactive mode, having seen moderate gains over the past week or so.

Yesterday, the pound broke through resistance at 1.2620. It climbed to a high of 1.2666, closing at 1.2648.

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Bank still proposing a series of hikes

Despite a highly visible downturn in economic activity in the country, the FOMC is still on course to levy two further hikes in interest rates, each almost certainly of fifty basis points, as it sees the reduction of inflation as its prime goal.

Although several observers believe that price increases are close to their highest point, Jerome Powell sees the normalization of interest rates as the Central Bank’s primary goal.

The Bank also plans to begin the reduction of its balance sheet next month, a move that has been predicted will have the effect of two or three further hikes in interest rates.

Having been caught out by the rapid rise in inflation last summer/autumn, Powell has recognized the damage that rising inflation can do to consumer confidence and retail sales, both of which have been mainstays of the recovery since the Pandemic.

It has been the view of the financial markets that any recession in the U.S. will come in early 2023. However, it was announced yesterday that the economy contracted by 1.5% in the first quarter.

Another sign of a faltering economy has been the rise in weekly jobless claims that are now well above the pivotal 200k level.

Yesterday’s figures showed that 216k new claims were made in the most recent period, raising the four-week average to 206.75k.

The fact that the economy shrank in the first quarter doesn’t necessarily mean that a recession is imminent. There were technical reasons for the fall, centred primarily around the trade gap. With the country spending more on imported goods than other nations did on goods imported from the U.S. It is estimated that the widening trade gap slashed more than 3% from Q1 GDP.

The dollar index remains in a corrective phase, driven by the expected reduction of the divergence in monetary policy created by other G7 nations beginning their tightening cycle.

Yesterday, the dollar index fell to a low of 101.73 and closed at 101.75, having broken support at 101.80 further weakness may be seen. However, a public holiday in the country on Monday, followed by the NFP data on Friday may see the markets pause for breath.

The first prediction for the headline new jobs figure is 375k, a moderate fall from April’s 428k.

Hikes and balance sheet reduction are simply tools

Although there has been some improvement in the Eurozone economy over the past few weeks, a recession is still the most likely outcome of the market as the ECB embarks on a programme of raising interest rates.

Prior to the Pandemic, the Eurozone was teetering on the edge of another debt crisis. This has only been deferred by recent events and with the ECB looking to reduce the size of its balance sheet, the effect of reducing liquidity by selling off its stock of Government Bonds will see interest rates increase.

While the growth and stability pact were virtually abandoned during the Pandemic, it is expected that in conjunction with higher monetary policy, Brussels will expect to regain control of fiscal policy, although the criteria may be a little looser than has been the case in the past.

The budget deficit that was set at 3% will most likely be increased, possibly to four or maybe even 5% while the threat of recession remains.

Meanwhile, debt to GDP ratios will remain high, but there will be an expectation that they are reduced to well below 100%.

Higher interest rates will, no doubt, bring pressure to consumers and see the level of confidence fall further despite a modest increase last month.

Banks will also suffer from an increase in bad debt as both consumers and businesses borrowed more during the Pandemic, not expecting such a significant rise in their debt burden.

As has been seen in the U.S. activity in the property market is likely to fall as homeowners grapple with higher interest rates on their variable rate home loans.

Economic activity measured by PMI’s continues to fall and this is likely to be exacerbated by ECB action in June, particularly since a fifty-basis point hike is out in the open.

Confidence measures are due for release next week and both consumer and manufacturing are expected to see further moderate falls.

Also, there is a leader’s summit beginning on Sunday. The main topic is certain to be Ukraine, but soaring energy process and likely ECB actions are sure to feature.

Yesterday, the single currency saw further moderate gains. It rose to a high of 1.0731 and closed at 1.0720

Have a great day!
About 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.”