28 May 2024: There are some tough calls ahead


  • Tax rises or spending cuts will follow the election
  • The Debt-to-GDP ratio reaches 127%
  • Can the ECB afford to “cut and run?”
GBP – Market Commentary

Both Parties have committed to bringing public debt down

The Conservative Party is choosing to ignore the Institute for Fiscal Studies warnings as it woos the older generation in the run-up to the General election.

The IFS believes that the UK will be “extremely lucky” to escape the need to either raise taxes or cut public services in the months following the General Election.

IFS claims that high-interest payments on existing debt and low expected economic growth could make reducing future debt more difficult to achieve, whoever is in government, than in any Parliament since at least the 1950s, without further measures.

While both the major parties have vowed to bring down borrowing, both are seemingly relying on an increase in the pace of growth, which will see larger tax receipts negate the need for taxes to rise,

Although the Conservatives have their well-known “plan” for the economy, the Labour leadership appears to be skirting the issue, continuing to criticize the Government’s performance while in power, without putting forward its proposals.

While the campaign is less than a week old, both parties have so far relied on their leaders to make keynote speeches while their “lieutenants” wait in the wings.

Rishi Sunak has made one significant policy change so far, proposing the introduction of a modern form of National Service for over eighteens. This is unlikely to be popular with first-time voters.

The campaign has already begun to take on the “standard impression” of past elections, with the Conservatives asking to be trusted, although they have abused that trust in recent years, while Labour says it offers “something new” despite being unwilling to say what that entails.

Both the main parties have also undertaken to retain the current level of taxation. However, the Conservatives already plan to bring down the current level of direct taxation if they are elected.

Given the “sameness” of campaigning so far, it may well come down to whom the electorate trusts more.

The first couple of weeks of any election campaign are usually characterized by Parties outlining the faults of their opponents. It appears that the Labour Party has begun the campaign for the better of the two. The Conservatives have suffered from several retirements of well-known faces and some defections.

It may be a truism that all Labour has to do is avoid any “banana skin” moments to win, but that is how the first week of the campaign feels.

The pound has so far not been afflicted by the uncertainty an election brings. Yesterday, in thin, holiday-affected trading, it rallied to a high of 1.2777 and closed at 1.2769.

USD – Market Commentary

The unwelcome news could snowball into stagflation

Citibank’s Chief Economist took a leaf from the book of his employer’s Chief Executive yesterday, issuing a grave warning about the current direction of the U.S. economy.

On the surface, the data is still predicting a level of growth of between 2% and 2 1⁄2% this year, but Andrew Hollenhorst is concerned that the likely “cooling” of the jobs market may present more serious issues.

Over the period since G7 Central Banks pushed and then ended their cycles of interest rate hikes, terms like stagflation and soft landing have been “bandied about” like they are everyday occurrences.

Both are economic rarities.

Stagflation is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment is still steadily high.

Although inflation is high relative to its historical average, it has been falling due to the Fed’s continued policy of leaving rates unchanged. While economic growth is possibly stuttering, it is not causing any undue concern currently, while the latest data still shows employment at a more than acceptable level.

A soft landing is a “Goldilocks” scenario when the economy is neither too hot nor too cold. It is the level, often fleeting, where the level of interest rates and inflation presents a situation where growth is rising while inflation is falling.

It has been the feeling for several months that the next non-farm payroll report is going to be the one where employment sees a significant fall. So far that has not happened, and it is wage growth rather than job creation that is causing the most concern.

It remains to be seen if patience will remain a virtue for the FOMC, or if the rate-setters will need to increase rates for inflation to fall close to their 2% target.

The radical view is that the “2% inflation” mantra is no longer practical as the world embraces more globalisation, although should Trump win the Election, that premise will be significantly weakened.

The latest figures for GDP will be published on Friday as well as the later data for Personal Consumption Expenditures. GDP is expected to have cooled from 2.6% to 1.4% in Q1 as monetary policy continues to play a role, while PCE inflation is predicted to have remained unchanged at 3.7%.

The level of PCE will mean that any hopes of a rate cut in June have been finally extinguished.

The dollar index is still under pressure and is now trading close to its short-term level of support. Yesterday it fell to a low of 104.57 and closed at 104.59.

EUR – Market Commentary

Time to look past June to the next cut

Comments made by members of the ECB’s Governing Council have finally become consistent. This means a rate cut at the meeting that is scheduled to happen on June 6th is all but confirmed.

Economists and market observers are already considering when the second cut will happen, although some of the more hawkish members of the Committee are already “pouring cold water” on speculation.

It seems that the most recent data has not been conducive towards a second cut taking place immediately. While there is little evidence of that, the ECB may probably want to see one or two months of reaction before sanctioning another cut.

The Eurozone economy is “crying out” for a rate cut, although it is interesting to note that Germany, the region’s largest economy and likely to be one of the major beneficiaries of a rate cut, also seems to be one of the most reluctant.

It is natural, certainly as far as the Northern European States are concerned, to want to be cautious about a cut in rates, having spent a significant amount of time dedicating monetary policy to lowering inflation, to be nervous about adopting a policy which will almost certainly lead to headline inflation rising in the short term.

Philip Lane, the ECB’s Chief Economist, has been one of the more realistic members of the Governing Council since the turn of the year, being prepared to be persuaded by the data. He brushed off fears that a divergence of monetary policy between the ECB and the Fed may backfire.

Having been criticized for being the last to hike rates, the ECB is still wary of the damaging effect of high inflation and fears that opening the door may lead to a rise in prices that could be difficult to control.

Nonetheless, Lane confirmed that barring major surprises, the Central Bank should be able to remove the “top level of restriction”. In other words, one cut is certain, but the next may be some time off.

The euro is still struggling to break above the 1.09 level and while the ECB insists that the rate cuts will not mark the beginning of a cycle of rate cuts, the single currency will attract buyers.

The acid test of ECB Policy will be how the market reacts to the cut. If it falls one or two per cent, traders may see that as an opportunity to buy, but trying to” grab a falling knife” may deter even the most resolute Euro bull.

Yesterday, the Euro rose to a high of 1.0867 and closed at 1.0859.

Have a great day!

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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.