30 January 2024: Construction output is in free-fall

The output data that was published last week showed that although the services sector has seen a significant rise in productivity, manufacturing output still is in contraction.

However, the “third leg” of the country’s GDP, construction, is going through another major downturn.

It would be simple to blame Brexit and the number of tradesmen from the mainland who have left the country since the UK left the EU, but the issue is more systemic than that.

The two main subdivisions of the sector, private sector new builds and repair and maintenance, are expected to contract by 2.1% this year.

As with several other areas of the economy, the high-interest rates have made mortgages expensive, while home improvements, the creation of additional space in domestic homes, through loft conversions and extensions, have been badly hit.

Although rates are expected to fall over the year, with five twenty-five basis point cuts predicted, the levels of security that banks are demanding from small and medium enterprise owners are becoming restrictive.

The House of Commons was told recently that in some cases, building contractors are being asked for one-hundred and twenty-five percent of the value of the loans to be placed.

That puts business owner’s own family homes at risk which they are often not prepared to do, especially as they run the risk of having their suppliers go out of business, owing sums which make their own business no longer solvent.

As interest rates fall, the outlook for 2025 is for the sector to bounce back, but it may be too late for several small companies.

The first cut in interest rates is now slated for May, although some commentators believe that it could be as soon as March. It is hoped that Andrew Bailey will supply some hints as to the thinking of the rest of the MPC at his press conference which follows the meeting on Thursday.

Inflation has halved, as promised by the Prime Minister when he took office more than a year ago, but disinflation will set in as it gets closer to the Bank of England’s 2% target.

There is no tier-one data due for release this week, so the market will pay full attention to the MPC meeting. It is expected that the number of votes for “no change” will rise from six to eight, with only Catherine Mann, judging from her recent comments, voting for another hike.

Sterling began the week similarly to each new week so far this year. It is still in a range, which is likely to remain unchanged until the first G7 Central Bank announces a cut.

The pound rose marginally yesterday to a high of 1.2719 and closed at 1.2710

There are no “fireworks” expected from the FOMC meeting, which takes place today and tomorrow. Despite the Fed’s propensity to shock the market, particularly when it is not expected to do so, the only possible surprise maybe if Jerome Powell “pushes back” against those who are predicting a cut in rates “sooner rather than later.”

Although the Fed is in the envied position of being able to say it is driven by data and mean it, several bankers, like Jamie Dimon at JPMorgan Chase, believe that if the cuts don’t begin soon, the economy is in danger of “falling off a cliff.”

The fall in inflation hasn’t ground to a halt, but headline price falls have slowed due to the geopolitical situation. With a significant percentage of global trade using the Red Sea and Suez Canal as a method of saving two or three weeks by avoiding having to “go around” Africa, any further disruption to shipping could see inflation reignite.

Powell, being a Republican, tends to look outside the country’s borders for issues that could affect the U.S. economy, while Democrats look far closer to home.

Senator Elizabeth Warren, who was critical of the Fed’s continued hiking of rates during 2023, has joined with three of her colleagues to call for rates to be cut at once to aid the housing market.

House prices surged at the start of the Pandemic and have remained high due to a lack of supply to the market.

This may be a topic Powell addresses at his press conference tomorrow, but it is unlikely that the FOMC will respond positively to the Senators’ demands.

The U.S. economy has pulled ahead of China as the “world’s manufacturer” is going through an economic entrenchment, while demand in the U.S. remains strong.

Consumer confidence is still strong in the U.S. while retail sales are holding their own despite the level of interest rates and the size of domestic debt which has reached record levels.

The dollar index again tried to break through short-term resistance yesterday, but again ran into selling pressure. It rose to a high of 103.82 but was driven back to close marginally lower at 103.42

Mario Centeno, the Governor of the Portuguese Central Bank and outgoing President of the Eurogroup of Eurozone Finance Ministers, spoke yesterday of his view that interest rate cuts should begin “sooner rather than later” and the increments should be small rather than abrupt.

Smaller increments would make sense since starting later and trying to “catch up” with a failing economy could produce panic in the market since it would give the impression of an emergency.

Centeno disagrees with Christine Lagarde who spoke after the ECB left rates unchanged last week, of her view that talk of rate cuts is premature.

It is easy to see why her staff gave Ms Lagarde such a low approval rating recently since it seems that she often simply follows the majority view of the Governing Council. This contrasts with Jerome Powell, who has spoken often of his views on interest rates, which differ from the eventual outcome of an FOMC meeting.

ECB Vice President Luis de Guindos also spoke yesterday. He believes that the risks to inflation are currently to the downside. The latest ECB survey shows that there has been a stabilization of the inflation outlook, and the disinflation process can continue.

He went on to say that he doesn’t fear contagion from the situation developing in China, which has led to the Hong Kong Courts liquidating Chinese Developer Evergrande.

Individual GDP data for some Eurozone members will be reported this week, with Spain and Italy publishing their results today.

There is likely to be a significant contrast between the two. Spain has seen its economy bounce back from the Pandemic as its tourist sector flourished. The Spanish economy is expected to have grown by 1.5% in the fourth quarter, after a 1.8% rise in Q3.

Italy, on the other hand, probably flatlined after a rise of just 0.1% in Q3. This is despite the Italian Government’s attempts to inflate its economy by introducing several measures that pushed its debt-to-GDP ratio and budget deficit to levels that will undoubtedly attract the interest of Brussels.

The European elections which will take place in early June will have no direct point of reference to the economy, since no matter the left or right “slant” of the winning group, they will have no direct influence over the actions of the ECB.

This may well be addressed going forward, but currently, the Central Bank is operating in its bubble.

The euro lost ground yesterday and is challenging the bottom of its short-term support. The market is searching for a catalyst that will give it confidence to drive the currency lower. It may come if Jerome Powell pushes back against calls for rate cuts tomorrow evening.

The common currency fell to a low of 1.0795 yesterday but rallied to close at 1.0831.

Have a great day!