18 January 2024: Inflation edged up to 4% in December

Rachel Reeves, the Shadow Chancellor of the Exchequer and likely to be the UK’s first-ever female finance minister sometime this year, gave a speech at the World Economic Forum in Davos yesterday in which she attempted to outline the Labour Party’s plans for the economy.

She spoke of “turbocharging” the economy, but while the speech was long on positive rhetoric, it was sadly lacking in substance. As Chancellor, she will be expected to “have her finger on the pulse” of the country’s finances but became very “woolly” when asked about how any changes, particularly around cutting NHS waiting lists, would be funded.

Following a keynote speech recently, her boss, the Leader of the Party, Sir Keir Starmer was asked a similar question, and he responded by using Labour’s current catch-all fund-raising scheme of abolishing non-dom tax status which appears to be the Labour equivalent of Theresa May’s “magic money tree”.

Sadly, when quizzed about actual figures, Starmer was only able to talk in very general terms.

There seems to be a real and growing concern that the Opposition may be becoming complacent about the election, just when the Government, at least as far as the economy is concerned, is on the cusp of turning things around, and regaining the country’s trust.

Last evening in Parliament, the Prime Minister faced down rebels from his own Party and won several key votes on his plans to send asylum seekers to Rwanda to have their claims processed.

While Labour is still well ahead in the polls, this is not the first time that the Conservatives have been trailing badly only to “pull a rabbit from the hat”, and Labour would be well served to remember that “it isn’t over until the fat lady sings.”

Inflation data for December was published yesterday, and it showed a small, yet surprising increase as headline consumer prices rose by 4%. The expectation had been for a continuation of recent falls, but energy and tobacco prices were the main contributors to the increase.

Core inflation, with those more volatile elements which caused the rise in the headline stripped out, was unchanged at 5.1%.

Sterling reacted positively to the data since it brings some doubt to the market’s expectation of when rate cuts will begin. It rose to a high of 1.2696 and closed at 1.2684.

The main topic of conversation from economists and market commentators currently is when the Fed will be comfortable to begin cutting.

It is a remarkably similar situation, although reversed, to speculation that grew in late summer last year about when rate hikes would pause and eventually be ended.

The FOMC has the luxury of being able to dictate its terms to the market, rather than being forced to change monetary policy due to the performance of the economy and the effect that has on its mandate.

The dual mandate of the Federal Reserve is to achieve maximum employment and keep prices stable, and recent data appears to show that it is achieving that goal, as the latest data confirms.

Inflation remains on a downwards, if not linear, trajectory, while the latest data showed that 216k new jobs were created in December, which is near the average for the whole of 2023.

While job creation is likely to average less than 200k this year as the legacy of rate increases remains, their effect on consumer prices remains positive.

Jerome Powell and his colleagues appear to have achieved the soft landing that the market was hoping for, but not expecting, even if inflation could always be a little closer to the Fed’s 2% target.

There will always be those with a contrarian view who are almost hoping for the Central Bank to “trip” up and either cut rates too soon, which sees inflation re-ignite, or leave rate cuts for a meeting, or two, too long, causing a dip in employment, but it is time for the majority of the market to trust Powell’s stewardship, even if he is a Republican during a Democrat Congress.

The next meeting of the FOMC will take place in just under two weeks. Although it is as certain as it is ever going to be that rates will be left unchanged, there will be a great deal of speculation about what, if anything, will be said about a timetable for rate cuts.

During January, Powell left comments about the economy and when cuts will take place to his colleagues and the consensus appears to be that the first cut will take place between April and June, but of course that will be data dependent.

The dollar index is running out of steam in its quest to challenge its next point of resistance. Yesterday, it rose to a high of 103.69 but fell back to close almost unchanged at 103.37, just three points higher on the day.

There has been a lot of chatter “around the sandbox” recently about when the ECB will begin to cut short-term interest rates. It is now the market’s consensus view that the Governing Council is not going to be swayed by fears of a long and potentially damaging recession and is only concerned about getting inflation down.

It will also only react to prices when they are at the Central Bank’s 2% target.

They are not prepared to be proactive in any way. That is since the Eurozone economy is only twenty-five years old and still in a state of constant evolution.

The nations who are crying out for rate cuts to begin, since they are fearful of their ability to grow their economies following a recession, are now entitled to ask the hawks what plans they must stimulate and even re-inflate the entire Eurozone economy in the second half of this year.

It will take some time for rate cuts to take effect, just as rate hikes are still working their way through into the economy, and Brussels will at some point want to reintroduce some form of restriction of debt-to-GDP ratios and budget deficits.

Philip Lane, the ECB’s Chief Economist, is still confident that the Central Bank will cut rates four times in 2024, even though the Governing Council’s “Hawk in Chief” Robert Holzmann spoke this week of his view that it may not be possible to cut rates at all.

It may be time for Christine Lagarde to intervene.

Of course, she cannot stop any member of the Governing Council from expressing their view, but the speculation that such widely diverse views generate cannot be healthy overall.

While Holzmann was performing his hawkish “duties” the former “Chief Hawk,” Bundesbank President, Joachim Nagel has reined in his more hawkish tendencies and agreed with market sentiment that cuts should be able to begin in the third quarter.

The first meeting of 2024 will take place next week, and there are those like Mario Centeno and Fabio Panetta who will vote for rates to be cut immediately.

Since the hawks believe that they made concessions by halting rate hikes when they did, they feel that the doves should be satisfied if rates remain unchanged.

The Euro bounced off its first level of support as risk appetite returned, if only slightly. It fell to a low of 1.0844 but rallied to close higher on the day at 1.0880.

Have a great day!