31 January 2025: The Chancellor has upset another powerful lobby

31 January 2025: The Chancellor has upset another powerful lobby

Highlights

  • Will voters allow Reeves the patience she needs but may not deserve?
  • The Economy grew by less than expected in Q4
  • Deutsche Bank profits collapse as the German economy reels
GBP – Market Commentary

Environmentalists are in an uproar over the Third Runway

Whether she believes it or not, Rachel Reeves will need time for her proposals to bring growth to the economy to fruition. The critical issue is whether she will be allowed that time since she is becoming deeply unpopular with the electorate.

The environmental lobby has joined pensioners, farmers and wealthy UK residents from overseas in facing policies that are driving higher taxes and the loss of income.

By and large, backbench Labour MPs support her, but should she lose that support by enacting policies like the means testing of the pensioner’s winter fuel allowance, that support could dry up very quickly, leaving her exposed.

Her redeeming feature is that she retains the complete confidence of the Prime Minister. The size of Keir Starmer’s majority will see the present Government retain power until, at least, August 2029.

While Reeves is to be commended for committing to a bold strategy for the UK economy that she expects to succeed over the long term, she is missing the less headline-making options that will provide her with small wins.

Today is the fifth anniversary of the UK leaving the European Community and no matter what Nigel Farage says, it has not, so far, been a success for the economy.

Brexit has been hugely divisive, both socially and politically. It has dominated political debate, with arguments continuing to rage.

The UK economy has not been afflicted by the malaise that began to afflict the Eurozone economy following the end of the Pandemic.

The Bank of England faces an extra dilemma ahead of next week’s interest-rate decision, with the slump in the value of the pound threatening to add to resurgent price pressures.

Bloomberg’s SHOK model is similar to the BoE’s method for predicting inflation in the months ahead.

It estimated that sterling’s drop against a trade-weighted basket of currencies since the BoE’s last forecast in the autumn will boost inflation by as much as a quarter of one per cent in the coming quarters.

Policymakers are having to consider both the United Kingdom’s stagnant growth and its sticky cost pressures when deciding the speed at which to continue cutting rates.

The pound was the world’s worst-performing major currency over the first month of the year when President Trump’s rhetoric created extra volatility after UK assets were hit by growing concerns over the sustainability of the Labour government’s fiscal plans.

Rachel Reeves was right in recently saying that every global event appears to have a greater effect and last longer for the UK.

Yesterday, even on a day when the market was fairly quiet, the pound experienced added volatility. It traded between 1.2476 and 1.2407 and closed marginally lower at 1.2435, leaving traders exasperated.

USD – Market Commentary

The FOMC welcomes Collins, Goolsbee, Musalem and Schmid

The FOMC is becoming dragged into Donald Trump’s economic rhetoric, even though it has no desire to react to political events.

In his post-meeting press conference on Wednesday evening, Jerome Powell had no option but to answer questions relating to the President’s plans for the economy. His answers were typically non-committal, although he did feel the need to say that one of the reasons that rates remain unchanged is the uncertainty over the economy created by new policies that are yet to be delivered.

U.S. interest rate cycles are driven largely by how restrictive or accommodative the Federal Reserve thinks monetary policy is. And right now, the picture is confusing.

After the Fed kept rates steady on Wednesday, Chair Jerome Powell said policy is still “meaningfully” restrictive, even after 100 basis points of cuts. But he also said that financial conditions are “probably still somewhat accommodative”.

So, which is it? Restrictive or becoming accommodative?

To quote Powell again, it’s probably “a mixed bag”.

Highlighting both views serves a purpose. It affords the Fed some breathing room and helps justify what is likely to be a lengthy pause in the cutting cycle. And with so much uncertainty swirling around the potentially inflationary impact of President Donald Trump’s tariff and immigration agenda, more breathing room is good.

With the Fed in no “hurry” to resume cutting rates, as Powell said, a ‘wait-and-see’ period may also be good for financial markets.

But the conflicting signals are potentially unnerving, particularly when FOMC members begin to give their views.

The Fed’s long-term expectation for the Fed funds rate is around 3% so considering that, rates are still restrictive. However, having lopped 100 basis points off the rate already, they would be considered as being well on the way to reaching thatz goal.

There has been a two trillion downsizing of the Fed’s balance sheet since 2022, which adds to the level of restriction.

Those commentators who are still concerned about inflation believe that rates should remain restrictive until inflation meets the Fed’s 2% target. There is no doubt that President Trump does not count himself as an inflation hawk.

So, the discussion will continue until the next FOMC meeting, which will take place on March 19th.

Later today, the latest figures for Personal consumption expenditures will be published. It is expected that headline PCE will have risen to 2.6% from 2.4% in November. This will add to the Hawks’ calls for a longer pause.

The Dollar index resumed its path higher yesterday as Powell’s comments were “net hawkish”.

It climbed to a high of 108.25 challenging its short-term resistance and closed at 108.15.

EUR – Market Commentary

A 25bp cut was agreed to by the Governing Council

The only question remaining when the ECB’s Governing Council met yesterday was the decision of how large the cut in interest rates would be.

In the end, the concerns that inflation is still above the Central Bank’s 2% target gave the Hawks the edge.

In her post-meeting press conference, Christine Lagarde strongly hinted that the path for further rate cuts is clear, as financing conditions are still restrictive amid an economy that stagnated in the fourth quarter.

The ECB cut its three key interest rates by 25 basis points on Thursday in a unanimous decision, as widely expected by market participants, bringing the deposit rate—the benchmark for Frankfurt’s monetary policy, to 2.75%. At least there appears to be no longer any conflict about continuing rate cuts, even though the committee has some “loud and strong” hawkish voices.

The main takeaways from the press conference were support for further monetary easing and the dismissal of Bitcoin as a reserve asset on the ECB’s balance sheet.

Cryptocurrencies are an asset class that I rarely, if ever, mention but moves to use them as reserve assets on Central Bank’s balance sheets call for some comment.

It is almost inconceivable that any Central Bank, let alone one that is a member of the G7, would ever consider using an asset which has no intrinsic value as part of its reserves.

While it is unlikely, Bitcoin could lose fifty per cent of its value overnight. This is not much different to its rally to $ 100k over the past few months. Central Banks should not expose themselves to such volatility.

Even the mention of Bitcoin as a reserve currency should send legislators scurrying to ban its use.

Lagarde indicated that the ECB will continue to adopt a data-dependent approach yet hinting that further rate cuts are likely if inflation continues to decline, and economic conditions warrant additional support.

“We know the direction of travel,” she said, stressing that incoming data would guide the pace and magnitude of future cuts.

The market’s expectation that the ECB will cut rates at every meeting from yesterday until July was reinforced since the economy is likely to continue to need bolstering throughout the first half of the year.

The Euro took the news of the cuts in interest rates quite well, falling to but not through its short-term support level. This was the fourth time it has fallen to test 1.0380 in the past week.

It recorded a low of 1.0386 and closed at 1.0407. However, since it is recording lower highs at almost every session, a break of the resistance is becoming more inevitable.

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.