28 September 2023: Bailey asserts that there will be a “meaningful fall” in inflation this year

The Government is gradually preparing for an election by both building a war chest that will allow it to provide tax cuts and making policy changes that are clear vote winners.

Yesterday’s announcement of a change of heart by Rishi Sunak that will allow the largest remaining oil field in the North Sea to be reopened is a perfect example of the changes that are taking place.

The Prime Minister faces as big a challenge in getting his own back benchers “onside,” as he does in the electorate to allow the Conservative five more years in office.

The extra revenue generated by the reopening of the Rosebank field will provide the windfall that Jeremy Hunt has been searching for to provide tax cuts that he is likely to announce in either his Autumn Statement or next year’s budget that will be delivered in the Spring.

The changes that have been made recently to the country’s net-zero policy are easily justified on economic grounds but will widen the rift between the Cabinet and the Green Lobby.

It will be hard for the Opposition to argue against the changes given that it is reasonable to expect that they too have been considering similar actions should they win the election.

The Lib Dems ended their annual conference yesterday, buoyed by their performance in the spate of by-elections that have taken place recently.

However, their leader, Sir Ed Davey faces a dilemma going forward. Having been chastened by their experience in joining a coalition in 2010, the only way that can make a meaningful contribution to the political debate would be if they made a similar arrangement with Labour if the result of the election made another coalition necessary.

Neither Party would relish such an “unholy alliance,” since their policies differ over several key issues.

The outlook for the economy remains unclear. With the Government clearly switching up to prepare for the election, people can expect to see further vote winning initiatives but with inflation data for September due the coming weeks as well as an employment report which will see the claimant count continuing to rise, the Bank of England will have an important part to play in cementing the feelgood factor that Sunak is trying to convey.

The pound fell yet again yesterday on its unerring fall towards a test of major resistance at the 1.20 level versus the dollar.

It reached a low of 1.2105 and closed at 1.2135.

Former Vice-President Mike Pence was an almost anonymous figure during this time working with President Trump. Trump looked upon the role of Vice-President as little more than a necessary evil while Pence bided his time knowing that at some point his chance would come.

With Trump showing that he has skin thicker than a rhino in still insisting on running for a second term in the White House, it may be that Pence fully expects Trump’s attempt will “wither on the vine” given the multiple criminal and civil actions he will face before the Republican convention takes place.

This would make Ron De Santis the Governor of Florida the clear favourite to gain the nomination to challenge President Biden, but Pence continues to chip away using tactics and proposed policies that he clearly learnt from his old boss.

After expressing his plan to replace Fed Chair Jerome Powell and to “shake up” the Central Bank’s mandate, he gave an indication of how he would approach industrial relations were he elected by blaming Biden for the strike that is threatened by the United Auto Workers Union.

Like Trump, Pence is more interested in the optics of the situation rather than the principal factors that have led to this conflict.

As the oil price blew past the $94 per barrel mark yesterday, it reaffirmed the conundrum that is facing Central Banks in the developed world. There is little doubt that the Chinese economy is still slowing and that will have a knock-on effect for the rest of both the developed and developing economy.

With G7 Interest rates being close to their peak, the rise in inflation caused by the spike in the oil price will bring the assumption that rates will remain” higher for longer” much closer to reality.

It is already suspected that the FOMC will continue with the pause in rate increases at its next meeting, but Jerome Powell and his colleagues must be prepared to act if the fall in inflation stalls.

Given the excitement that the recent monetary policy meetings generated in the market, the current situation has more to do with both the longer-term ramifications for the economy and when the programmes of rate hikes will end.

The dollar looks set to continue to gain as the ECB appears to be actively ignoring the economic reality of continued rate hikes. The Greenback continued its climb yesterday, reaching a high of 106.83 and closing at 106.70.

Given that the index is made up predominantly of Sterling and the Euro which combined make up close to 70% and a weaker JPY being favoured by the Bank of Japan given its primarily export led economy, the dollar is still “the only game in town” as a store of value.

Banks in Germany have railed against proposals from the ECB that the level of reserves that banks domiciled in the Eurozone must keep with the Central Bank are increased to drain liquidity from the market.

They have called it a stealth tax on their lending potential, although recent figures show that appetite to borrow has been falling for most of this year.

Data released this week has shown that money supply, the amount that is “sloshing around” in excess liquidity has fallen considerably.

Adding fuel to the flames, Austrian Central Bank head and ECB Governing Council Hawk Robert Holzman is considering proposing a ten-fold increase in the level of reserves that must place with the ECB. Such a proposal would have a significant effect on banks across the entire regions’ ability to satisfy their customers’ needs and have the effect of raising interest rates by at least 100 basis points, but without the economic effect.

Holzman believes that such a move would take the pressure off consumers who have seen prices rise by close to 10% on a year-on-year basis while their savings and pension pots have only risen by around an average of 3% in the same period.

The implementation of a digital euro is still at least two years away according to ECB President Christine Lagarde who is a supporter of its introduction.

Addressing some of the concerns of the European Parliament yesterday Lagarde spoke of the need to not only have secure systems in place but that the regulator to be able to prove that they work.

The Central Bank is engaged in a two-year investigation into the design, implementation, and general appetite for a digital euro.

The investigation has ramifications for other Central Banks which are allowing the ECB to do the leg work allowing them to simply consider the political ramifications of digital currency.

Francois Villeroy de Galhau, the Governor of the Banque de France continues to take a leading role in policy discussions at the ECB. Yesterday he spoke of the need for balance in not cutting interest rates before inflation is truly defeated but on the other hand being wary of raising rates to such an extent that it completely chokes off demand.

There is no question that France sees itself in a position to be the voice of reason on the ECB Governing Council. It currently has no “skin in the game“ for raising rates further since its inflation rate is “controlled,” while growth, while hard to come by, is still above recessionary levels.

The euro remains under pressure with investors and traders seeing little benefit in holding long positions. Yesterday, the common currency fell to a low of 1.0488 and closed at 1.0502. Having now cleared the area of condition around the 1.0520/40 area, there seems to be little to stop it falling close to parity with the dollar.

Have a great day!