12 July 2024: The “Tory legacy” gives Labour a boost

The UK returned to growth in May as the economy grew by 0.4% after flatlining in April.

The news gave a boost to the new Labour Government, which has pinned its spending plans on seeing the economy grow to such an extent that it will not need to either raise direct taxes or increase borrowing to fund its manifesto undertakings.

While the Prime Minister has been in Washington attending a NATO summit, he will face his first major dilemma upon his return.

Bank bench Labour MPs are considering rebellion over the “two children” limit on child benefits.

Several new MPs have said they believe the policy leads to poverty and have vowed to get it scrapped.

Starmer has said that while he agrees with scrapping the limit, it is presently unaffordable.

In yet another policy initiative, Chancellor Rachel Reeves is creating a council of economic advisers in the Treasury to guide the Government in promoting growth and evaluating proposals.

In its latest review, The IMF dates the UK’s growth prospects as “subdued” due to an ageing population and the high level of members of the population who are long-term sick or have not returned to work since the Pandemic.

The Fund predicts growth of 1.3% this year, just below what the Office for Budget Responsibility predicted.

Reeves faces a dilemma in delivering the “substantial” growth needed for the country to stabilize public debt and not face difficult choices between higher taxation and public spending cuts.

Several of Reeves’ economic advisers have been “tipped” to join the Council as she tries to widen the breadth of her team at the Treasury. In the past, Labour administrations have been accused of diluting Ministers’ authority by creating “think tanks” that they can blame if the policies do not achieve the expected results.

The pound rallied to its highest level versus the dollar for a year yesterday, reaching 1.2919 and closing at 1.2914. Versus the single currency, it rallied to 1.1887 and closed at 1.1883.

The Bank of England is under pressure to begin to cut the base rate of interest at its next meeting, due to take place on August 1st. Sterling’s path over the next month will be dictated by the market’s perception of economic growth and changes to monetary policy.

The FOMC is facing pressure to begin to loosen monetary policy as the economy shows signs of slowing down.

Fed Chair, Jerome Powell, has been clear in his guidance to the market that the Central Bank will be guided by the data, although he has not given any indication of where he needs headline inflation to reach or how much he needs employment to cool to agree to a rate cut.

As the election appears on the horizon, Powell told Congress this week that monetary policy cannot and never will be a political decision.

Powell has faced criticism during his second term in office for being a member of the Republican Party, irrespective of his suitability to carry out the role.

Although the number of new jobs created has slowed significantly during the first two quarters of the year, it is still of sufficient concern to FOMC members to delay a rate cut until September, while the rate of inflation, which was published yesterday, shows that the pace of deflation picked up a little last month.

Headline inflation was 3% in June, down from 3.3% in May, while the core rate, with more volatile items like energy and foodstuffs removed, fell marginally from 3.4% to 3.3%.

The ex-managing director of the World Bank, David Malpass, told reporters yesterday that the economy is slowing down under President Biden, and it is only seeing any growth at all due to the elevated level of Government spending.

The second half of the year was always going to be characterized by changes in G7 nations’ monetary policy.

With the ECB resisting calls for another rate cut immediately following the cut it agreed in June, both the FOMC and MPC face further pressure to boat activity by imminently cutting rates.

Producer price data is due for publication later today. It is expected that “factory gate” prices in June, will have risen to 2.3% from 2.2% in May. This may well cause the Fed to continue to be cautious about a rate cut given their fear of reigniting precise rises.

The dollar index is still driven by the prospect of a rate cut at the next FOMC meeting. Yesterday, it fell to a low of 104.07 but recovered to close at 104.46.

There is strong medium-term support, with buy orders placed between 104.00 and 104.20. A strong producer price figure today may provide some support, although the medium-term trend is lower.

It is hoped that the “big three” economies of the Eurozone will see significant benefits from the global sporting events that are taking place in the region this summer.

With Euro 24 reaching its climax on Sunday, the Tournament has been hailed as a significant success with crowds exceeding expectations, which is sure to boost German consumer spending which had been lagging in recent months.

With the Paris Olympics two weeks away, France can expect a similar, or possibly even greater boost, to its ailing economy.

The political turmoil that has threatened to engulf France in the last month makes President Macron’s decision to call a legislative Election when he did all the more bizarre. Nonetheless, the entire nation is now looking forward to a month of intense competition, hopefully, free of any major controversy or incident.

The third member of the Eurozone’s big three has seen an impressive improvement in its economy this year, with inflation down and the economy growing.

Similar to the U.S. the Italian economy is relying largely on spending by its far-left government for growth. Without doing anything particularly radical. Giorgia Meloni’s Government has gained in popularity.

The debt-to-GDP ratio is expected to reach 137.8% by the end of the year, while its budget deficit is forecast to fall to 4.4% this year as emergency energy-related payments have ended.

At the end of last year, it was an eye-watering 7.4% and by the end of March, it had reached 7.2%.

Preliminary data released for the first half of the year has shown that outside of the major events taking place, the “big three” economies are all in need of help to drive growth between now and the end of the year.

Germany has seen some positive surprises, despite a weak start to H2. Weak industrial orders and high levels of inventory point to a lack of competitiveness. Germany is most affected by China’s growth over the past five years and will find it difficult to compete in the future without a radical change to its economy.

France has lost its momentum in the first quarter of the year. Confidence has been badly eroded by the political turmoil that threatened to split the country.

With continued turmoil likely for the rest of this quarter, it will need a strong end to the year to see positive growth at all.

Italy hopes to see an increase in private investment in large infrastructure projects if it is to avoid sanction from Brussels over its public spending.

Overlaying the Big Three’s economic plans is another much-needed rate cut from the ECB, but its Governing Council seems unlikely or unwilling to “play ball”.

The Euro rallied to a high of 1.0899 yesterday and closed at 1.0968. There has been strong selling interest above 1.0920 for a considerable time, and the common currency may well be close to the top of its long-term range unless the ECB can resist calls for a rate cut until deep into the fourth quarter.

Have a great day!