30 December 2022: Government support for SMEs

As the threat of recession grows, banks are beginning to tighten lending standards in order to provide a cushion against possible non-performing assets.

This is making it considerably more difficult for small and medium-sized businesses to secure funds to survive a slowdown in economic activity.

Just as the Government stepped in with various support packages during the Pandemic, there are calls beginning for a similar amount of aid, in the form of guarantees, to be provided again. If Jeremy Hunt takes his time in considering his options, the time may have passed, given the pace at which the economy is contracting.

As banks make further provisions for bad loans, their profits will fall, which also restricts their ability to lend.

In addition to the contraction in the economy, inflation continues to rise which pressures the Bank of England into tightening monetary policy, which means that support has to come from the Government or Treasury.

It will be summer, at least, until inflation is under any sort of control and the Central bank can consider easing interest rates.

The current wave of industrial action in the public sector is expected to worsen as the current disparate trades unions which represent various sectors of the workforce are rumoured to be in discussion about consolidating their actions into a general strike.

It is also rumoured that the Government is likely to maintain its current position where they insist that there is no more money available to pay increased demands, which in any case would add fuel to the fire of inflation.

Rishi Sunak is showing a different side to his character and appears to want to become embroiled in a battle of wills with union leaders. The one disadvantage the unions have is limited resources, which will, in all probability, begin to dwindle away, taking their resolve with it.

It is going to be a tough first quarter for the economy as stagflation begins to take hold.

In practicality, the only winner in the current wave of strikes has to be the Government as any other path will simply prolong rising prices.

The pound has been virtually becalmed this week. Yesterday, it fell to a low of 1.1992 and closed at 1.2023.

At the beginning of the year, the Federal Reserve was still living in Jerome Powell’s fantasy world in which inflation was little more than a transitory blip.

It took them until the spring to shake themselves out of this tauper and consider that tighter monetary policy was needed to counter rising prices that apparently saw no end.

Now, after seven consecutive rate increases, the Central bank stands on the cusp of another change of policy.

The next week could determine the path for both interest rates and the economy. As traders return from their Christmas and New Year holidays, they will immediately be confronted by the minutes of the latest FOMC meeting.

The minutes of the previous meeting had a significantly dovish tone, which led the market to, correctly, believe that the Fed was considering tapering the size of any further hikes. By hiking for fifty basis-points rather than the seventy-five points that had preceded it, they began a correction for the dollar index which is continuing.

While the minutes will occupy the minds of the market for the first week of the New Year, the collective minds of the FOMC will be exercised by the December Employment Report, which is due for release a week from today.

The latest estimates are for 250k new jobs to have been created. This is a strong number considering what has gone before. Some sectors will be satisfied with 200k, while there are those who will be happy as long as it is in positive territory.

The next FOMC meeting is taking place on February 1st. It is hard to see past a fifty-point hike, although there is plenty of water to flow under the bridge in the shape of a full month’s data, although a radical departure from what has gone before seems unlikely.

The dollar index has found a degree of support since its recent correction around 103.75, but traders are reluctant to take fresh positions ahead of next Wednesday. Yesterday it tested the support again but managed to close at 104.98.

The ECB has had a tough year, having to balance the demands of the frugal five who are demanding that tighter monetary policy is necessary to curb rampant inflation, while the weaker, more indebted, nations look to the Central Bank to provide support for them as their government bond prices collapse leading to ever higher rates of interest.

Over the period of the past two ECB Governing Council meetings, the Central bank’s President, Christine Lagarde has straddled both positions, sympathizing with the fate of Italy, Spain et al., but siding with the likes of Austria and Germany, by sanctioning higher interest rates.

Ms. Lagarde’s position has become even tougher in recent weeks as inflation has begun to stabilize. The rate hike agreed at the last meeting saw most of the Italian Government up in arms.

The fact that short-term interest rates have remained so low for so long has meant that they have fallen a long way below what are considered neutral.

Therefore, the ECB should have used larger increments to bring them into restrictive territory sooner. That would have seen inflation stabilize sooner, as it is time, not the rate itself that is the issue. The sooner rates are allied to remain stable, the better the Italians are able to plan their economy.

Energy prices remain an issue, it took several months and interminable meetings to agree on a cap for the price of gas. The European Union has spent close to a trillion euros trying to protect its citizens from the cost of rising energy prices.

This highlights the difficulty of having a monetary union without a fiscal union. It is remarkable that, despite a couple of well-known hiccups, the euro has survived for more than twenty years.

It is not outside the bonus of possibility that another crisis could be on its way, but the ECB appears to believe that forewarned is forearmed. The market just may not see it that way.

The euro saw a degree of support yesterday, reaching 1.0690 but fell back to close at 1.0668.

Have a great day!