31 May 2024: Starmer would do well not to lean too heavily on business for support

31 May 2024: Starmer would do well not to lean too heavily on business for support


  • Loss of social housing costs the economy £1.4 billion a year
  • The labour market stands between the economy and stagflation
  • Confidence data seems to have bottomed out
GBP – Market Commentary

Fiscal headroom is the great balancing act

The Labour Party has made a lot of the fact that it has received a letter signed by over one hundred business owners pledging their support for a change in Government.

While this support will do the Party no harm, it is not going to be the sea change that the Party needs to be able to consider itself “the Party of business”.

This election is devoid of personalities that make a difference to the “big picture”. Love him or loathe him, the Conservative victory in 2019 was due to the galvanizing effect of Boris Johnson’s larger-than-life personality.

Unfortunately, the fact that he was so dreadfully let down and betrayed by those around him shows how fickle politics in the UK is and drives home Harold Wilson’s famous quote that a “week is a long time in politics”.

Boosting economic growth while supporting sustainable levels of public spending is a huge policy challenge for the UK. The government’s self-imposed fiscal rules may themselves function as a constraint. Reforming those rules could help to revive the country’s stagnant economy.

Poor economic performance has put pressure on the Treasury and reduced “fiscal headroom”, the gap between public finances and spending plans. The cost of borrowing to finance the gap between the country’s income and expenses has been prohibitively high in recent years.

Improving the performance of the NHS, improving education standards and upgrading transport infrastructure will be the most significant challenges for whichever Party is first past the post in July.

While the Conservatives are introducing new policies that are simply “placing plasters on a gaping wound”, it is hard to believe that Labour is capable of introducing the improvements to services it is promising while not increasing the overall tax burden.

There are still five weeks to go until the country goes to the polls and despite its seemingly unassailable lead, the Labour Party, according to political commentators, is not exciting the electorate. A policy of “anyone but the Tories” may well win the election, but it will not see the living standards of the “man in the street” improve, which after all is the primary duty of any Government.

When Ben Bernanke, economics Nobel laureate and former chair of the Federal Reserve, was invited to evaluate the Bank of England’s forecasting for monetary policymaking and communication. While his review makes several recommendations, the Bank of England appears reluctant to adopt them.

It seems as if this was an expensive “box-ticking” exercise which Andrew Bailey and his colleagues have treated as “yet another outsider who does not know how things are done here”. Radical is not a word associated with the MPC, but if the committee is not committed to radical reform, it may well find itself having its independence watered down by a Labour Government which won’t like to “outsource” significant policy decisions.

The pound staged something of a recovery as the data published in the U.S. was weaker than had been expected. It rallied to a high of 1.2743 and closed at 1.2732.

USD – Market Commentary

Consumers have shown less confidence in the economy this year.

It is becoming something of a cliché, but next week’s publication of the employment report for May is shaping up to be a “game changer”. Economics has a lot to do with perception, with “glass half full” theories abounding.

The U.S. has produced millions of new jobs over the past eighteen months while the Federal Reserve raised interest rates and then held them at a level which was expected to see job creation wither and die.

Now with pressure on the Fed to cut rates, the economy is still expected to have created close to 150k new jobs. It is glib to simply say that the economy has moved into a new “paradigm” in much the same way as 3% is the new 2% when inflation targets are discussed.

It may well be that Jerome Powell was right when he called for patience at the start of the year, certain that the level of interest rates was correct, and eventually, they would bring inflation down.

The key to ending the status quo that has developed over the past few months when the pace of deflation has stalled is for the economy to produce fewer new jobs. This in turn will end the laissez-faire attitude of the workforce to the prospect of finding new jobs if their own disappears.

Consequently, wage demands will fall which will bring inflation down.

Powell and his colleagues on the FOMC did not see the continued creation of jobs as we entered the second quarter at 175k.

Any change in monetary policy is not warranted currently. Monetary policy is such a blunt instrument that neither a cut nor a hike would have the desired effect on either inflation or growth, and more patience is necessary.

A few commentators are saying that the Fed is risking stagflation by continuing to leave rates unchanged. This is little more than a scare tactic by a group which is desperate to be proved right.

Even if the headline rate of job creation falls to around 50k or less when it is published next week it will not be a sign that the “sky is falling” merely the natural cycle that has been slow to develop but is developing, nonetheless.

The dollar took a breather yesterday as short-term long traders took profit ahead of what is expected to be a volatile week.

The index fell to a low of 104.63 and closed at 104,75, still well above its short-term support level.

EUR – Market Commentary

Jobs data won’t encourage further cuts.

It is hard to describe falling unemployment as a problem for the European Central Bank, but as the economy begins to slowly pick up and the number of jobs in the region picks up, it is hard not to get the feeling that the hawks on the Bank’s Governing Council have not been “bounced into” the rate cut that is almost guaranteed to take place next week.

At least the ECB won’t face charges of political bias in cutting rates immediately before an election., This has a lot to do with the “economic disinterest” that the European Parliament constantly displays even if Ursula von der Leyen pays lip service to the region’s economic performance.

There is a divergence between the undoubted pleasure that MEPs will glean from the fact that the region is not facing high unemployment just as the electorate votes to allow them another term on the “Brussels gravy train”.

In Frankfurt, where the ECB is headquartered, the mood may not be as cheerful as it is likely that inflation is going to increase in the coming months.

A one-off rate hike, which is becoming increasingly likely to be the result of several months of speculation about the balance between prices and growth, will do neither camp much good.

Christine Lagarde has been quoted several times since the start of the year as saying that she would only vote for a cut in interest rates if she believed that inflation had been defeated.

The data published for inflation so far this month does not justify a rate cut, but the hawks appear to be on the cusp of giving in. It seems that they have “beat a retreat” determined to defend calls for further cuts before the Autumn.

This perfectly illustrates the absurdity of being “data dependent” especially when a monetary policy cycle is ending. The data is often skewed as the economy reacts to interest rates that are possibly too high for the situation the economy has reached that prompted the change in the first place.

Next week will undoubtedly see an increase in volatility. Lagarde will be making what is likely to be the most important address of her tenure as President of the ECB. She will need every ounce of her indisputable diplomatic talent to satisfy all parties to the decision.

The euro is likely to head into the week on a reasonably strong footing. It rallied to a high of 1.0845 yesterday and closed at 1.0831 as it erased a large part of its losses so far this week.

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.