Chancellor accused of avoiding the tough issues

When he first became Chancellor, Rishi Sunak quickly became extremely popular as he oversaw several handouts to those most affected by the Coronavirus Pandemic.

The furlough payments and the eat out to help out scheme saw him cap a meteoric rise to be the Prime Minister’s major rival in any future leadership contest.

However, canny observers predicted a time when Sunak would expect the population to pay for his generosity.

In the year from March 2020, barely a single derogatory word was written about his performance, but suddenly he has become the pantomime villain, holding the country’s purse strings ever more tightly and facing accusations of throwing out crumbs to the people from his ivory tower.

Of course, as with most political stories, the truth lies somewhere in the middle. The handouts provided during the Pandemic were necessary to support the economy and had very little to do with generosity.

Equally, the rise in National Insurance contributions that begins this week has been made to provide support for the country’s beleaguered National Health Service, which has been chronically underfunded for a decade.

Sunak’s most recent actions have led him into direct confrontation with the Prime Minister. Boris Johnson is never keen to hear unwelcome news or to inflict any action on the country that could affect his popularity among voters.

Their latest spat involves the proposal to build a number of nuclear power stations to reduce the country’s dependence on fossil fuels. Johnson sees this as a flagship project to protect the nation.

Sunak, ever practical, refuses to endorse such a huge investment that will place a significant burden on future Governments. Johnson, who lives in the now, believes that bridge should be crossed when it is arrived at.

Sunak’s version of living in the now is staving off criticism that his most recent proposals do nothing to alleviate a fall in living standards that is predicted to be the worst since records began more than fifty years ago. He has, to a considerable extent, become a victim of his own success with his cautionary words at the time he introduced the furlough scheme, warning that at some point it would have to be paid for being largely ignored.

Rather like sitting in the dentist’s waiting room, the country is waiting with trepidation for energy bills to begin to arrive once the energy cap is raised this week.

Meanwhile, the Bank of England continues on its path, raising interest rates to rein in rising inflation, which has its origins in events out of the control of either the Chancellor or the Bank’s Governor.

The pound began the week under pressure as traders looked to test support close to the 1.3000 level versus the dollar. It ran into a degree of buying interest but was only able to rally to close at 1.3086 having earlier fallen to a low of 1.3066.

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Supply side seeing inflation, buy side seeing slowing

All the problems that are currently facing the U.S. economy emanate from the supply and demand side of the economy. There is no doubt that the Federal Reserve was more than a little complacent and took its eye off the ball as issues with supply chains came to prominence last summer.

It is unusual for a Fed Chairman to be accused of being glib, and just as unlikely for that term to be used about a prominent lawyer, yet Jerome Powell has been forced to accept his mistakes.

The now defunct term transitory will be forever attached to the economic events in the U.S. during the term of the Pandemic.

It was a failure of economic intelligence that no one at the Fed was able to predict that China would need to buy a vastly increased amount of natural gas to augment its other energy imports once its economy reopened after coronavirus.

That, rather than a belief that inflation would fade as fast as it arrived, was the real mistake.

Exacerbated by the conflict in Ukraine, it is the price of energy that is going to keep inflation at a heightened level for at least the rest of this year and possibly well into 2023.

The Fed, with hindsight, will agree that the removal of support should have started far earlier than it did, but the FOMC was more concerned at that time by fears that the Pandemic would drag on even more and employment would be sluggish.

After one or two false starts, the most recent employment data has been encouraging, while those registering jobless claims have fallen to a level unprecedented in modern times.

It may be that the future of the economy has been radically changed by events of the past decade.

The old boom/bust cycle where the economy grew, much like an overinflated balloon which would burst and drag the economy back to reality, may be replaced by a sequence of scenarios where Central banks are allowed to recognize the signs of danger sooner and reduce the level of over inflation before it becomes terminal.

The early predictions for this week’s headline NFP data are for 475k new jobs to have been created. The fact that the past two headlines have exceeded expectations places a risk to the downside.

The dollar index rallied yesterday, but ran into some selling above the 99 level. It reached a high of 99.36, but was unable to break resistance above 99.40 and fell back to close at 99.14.

Lagarde still can’t see stagflation risk

Christine Lagarde is a very experienced political figure and has held a series of senior posts, not least as Managing Director of the International Monetary Fund between 2011 and 2019, before succeeding Mario Draghi at the ECB.

Therefore, when she speaks, the financial community listens. Her most recent comments have been around her view that stagflation is not an issue for the Eurozone, and the most recently released data supports her view.

Such an experienced financier and banker should be willing to look beyond the data to understand the underlying influences that are driving the economy.

Her stubborn refusal to countenance, first a reduction in the support that is being provided through bond purchases, then a hike in interest rates, flies in the face of popular wisdom.

It may very well be that Lagarde is correct to continue to demand that the ECB supports the economy of those countries that continue to suffer, but she runs the risk of allowing inflation to remain elevated for some considerable time.

Add to this dilemma, the potential harm that may be done to the economy by the continued conflict in Ukraine and there is a genuine possibility of stagflation that may not yet be reflected in data releases. Nonetheless, the drop seen last week in consumer confidence is a tell-tale sign.

In an interview published yesterday, Lagarde spoke of her belief that there will be no recession in the Eurozone based upon the region’s strong labour market performance.

She went on to affirm that in two estimates for the economy, produced by her staff, in the more severe outlook growth is still 2.3% for 2022, although there still is a high degree of uncertainty.

The Eurozone has reached the level of output that was being seen pre-pandemic, although there were concerns being aired prior to the arrival of Coronavirus.

Lagarde is avoiding mention of how, or even if, the ECB will reduce the size of its balance sheet, and it may be that the Bank will keep its current level for some time to come.

The euro continues to be at the mercy of the dollar, although there remains some interest to buy for now, at sub-1.0950.

Yesterday, the single currency fell to a low of 1.0944, but rallied to close at 1.0980. The 1.10 level appears pivotal for now, and a lot depends on the data to be released in the U.S. this week.