24 January 2024: Sterling climbs versus the Euro

It is not a piece of data that usually excites the market, but yesterday’s publication of the latest figures for the Government’s borrowing requirement provided Chancellor, Jeremy Hunt with an opportunity to make good on his promise that he will be able to cut taxes in his Spring Budget, that is due for delivery in early March.

The data showed that the Government needed to borrow just £6.86 billion in December, down from a slightly revised figure of £12.78 billion in November and well below the market’s expectations.

This means that the interest payable on the Government’s borrowing requirement will also have fallen, providing the Chancellor with yet more “wiggle room”.

The interest payments on the entire UK Government debt have fallen from £14 billion to £4 billion in a little more than a year since the interest payments are linked to the Retail Price Index measure of inflation, which has more than halved over the same period.

The Office for National Statistics reported that in the nine months to December, the Government borrowed a total of £119.1 billion, which was more than £11 billion more than over the same period a year ago, but significantly less than the amount forecast by the Office for Budget Responsibility.

This makes some headline-making tax cuts in March like a one per cent cut in the basic rate of income tax, which is estimated to cost close to £7 billion, as well as a freeze on fuel duty, which will cost roughly the same as a tax cut, more likely.

Despite the fall, the country’s debt-to-GDP ratio is still uncomfortably high, at 97.7%, according to the ONS. Government borrowing has increased significantly over the past few years, due in no small part to the amount that had to be borrowed to finance measures to deal with the Covid-19 Pandemic.

This data added to the general improvement in the outlook for the economy, which is expected to provide the Bank of England with an incentive to begin to lower rates from their highest level in more than ten years.

While the rate cuts should begin in the first half of the year, it is considered unlikely that the first cut will be made at the MPC meeting that is due to take place next week.

The latest market prediction is for around 100 basis points to be delivered this year, which is less than expected in other G7 nations.

That has led to Sterling rallying to a four-month high of 1.1702 versus the euro, although it still lost ground against a strengthening dollar yesterday. It fell to a low of 1.2687, although it rallied to close at 1.2708.

The market’s level of expectation from next week’s FOMC meeting is still low although traders and investors are still wary of the Fed’s ability, which has been seen before even if that was under more “outgoing” Chairmen than Jerome Powell, to spring a surprise.

The speeches that have been made by regional Fed Chairmen like Austen Goolsbee, Neel Kashkari, and Raphael Bostic have, in the main, concurred that although rate cuts are coming, inflation is not yet sufficiently controlled or close enough to the Fed target of 2% to be considered “anchored” at that level.

The man who was considered by a recent Bloomberg Survey to be the “best” economist in the world, Christophe Baraud, from Market Securities, believes that Growth in the U.S. economy will reach 2.5% this year, which is marginally more bullish by his associates, while he sees a fall in inflation to between 2% and 2.5% by the end of the third quarter.

He believes that the battle against inflation has been won by the Fed, provided there are no shocks this year. Given the current geopolitical situation, it may be a big ask.

Baraud sees the first cut taking place in May, as he believes that March will be considered too soon from an overall hawkish FOMC.

This week’s data releases are unlikely to have any lasting effect on the outlook for the economy since Q4 GDP is unlikely to be changed from the 4.9 estimate that has already been made, while Personal Consumption Expenditures, Jerome Powell’s favoured measure of inflation have, in the main, followed CPI over the past two quarters.

Durable goods orders are too volatile to be able to be indicative of the medium strength of the economy other than in the very short term.

The dollar is beginning to benefit from the overall market expectations for the U.S. economy and is being less driven by the market’s desire for rate cuts to begin sooner “rather than later”.

Yesterday, the dollar index rose to a high of 103.81, and although it fell back to close at 103.51, it is beginning to show strength just as other G7 currencies are beginning to reflect concern about the sustainability of even a moderate rate of growth.

even though she has a far more “glittering” CV than almost all of her predecessors as President of the European Central Bank, the news that staff at the Central Bank rated Christine Lagarde’s performance over the first half of her tenure as poor, or very poor, shows that the job is better suited to a technocrat than a diplomat.

Lagarde sees the role as more of a stepping stone en route to higher office than her predecessor.

Mario Draghi saw the role of President of a Central Bank that oversees monetary policy that affects more than 350 million people’s lives as the pinnacle of his career, even though he went on to be Prime Minister of Italy.

Her failings have been well documented over the past few days, but her inability to “run a tight ship” has led to the most criticism outside Frankfurt.

The market feels that it is the more hawkish members of the Governing Council who are dictating policy, which would be reasonable if it was done democratically. Still, she allows the likes of Robert Holzmann and Martins Kazaks to speak with a degree of authority that should not be considered any more pertinent than that of any other member of the twenty-man Council.

She has wielded enormous power for more than fifteen years, but it is only now that her performance has come under the microscope in a wider context.

As French Finance Minister, she squandered an opportunity to reform which cost Nicolas Sarkozy an election, while as Managing Director of the IMF, she oversaw the imposition of austerity on Greece that created a greater fall in output than was seen in the great depression.

A compromise candidate at best, she was elected to her role to allow a German to assume the position of President of the European Commission since the election of Jens Weidmann, the clear favourite for the job was not considered “fair” by Angela Merkel.

The market is beginning to see that the ECB may be so far “behind the curve” when cutting interest rates that a recession is not only considered acceptable but inevitable.

Given the recent comments made by members of the council, of all shades of “hawkishness”, the market cannot make a more accurate prediction than “any time in the second or third quarter” for rate cuts to begin, which may by then already be too late.

The euro has fallen through the level of support that has sustained it since the turn of the year.

Yesterday it fell to a low of 1.0821 and closed at 1.0849. Its short-term path will be guided not by the outcome of tomorrow’s rate-setting meeting but by the comments from its under-pressure President.

Have a great day!