5 August 2024: Reeves may ignore another pledge

While considering every option to repair the damage she has found in the country’s finances, the Chancellor is considering breaking another of the pledges she made at the time of the General Election.

There is little doubt that Labour would have won the election without the pledges that it made in its manifesto, which were eminently difficult if not impossible to achieve.

If they had said, “Yes, we may need to raise some taxes, and need to borrow more”, but it is the only way to get the country back on track, the electorate would have been able to respect her. Still, the Prime Minister was “hell-bent” on not letting any “gaffes or banana skins” derail his ambition to enter 10 Downing Street.

Rachel Reeves will likely raise her debt target in October when she delivers her budget to MPs.

By October, Reeves will need extra funding, having been almost profligate in her first weeks in the role.

She has not been concerned about her popularity in her quest to rebuild the foundations of the economy, although there is little doubt that she was aware of their parlous state during the election.

Politics is about perception and optics, with individual policy decisions often forgotten if there is a long-term plan which is continuing to move forward.

The riots that have been taking place up and down the country are too well-organised to be merely random acts sparked off by the horrendous events in Southport. Keir Starmer and his Home Secretary Yvette Cooper will need to make law and order a priority with actions rather than premises if a “summer of discontent” is to be avoided.

Last week, Starmer hit the tech sector hard, abandoning an undertaking of the earlier government to invest heavily in artificial intelligence. Overall, this may have been very sensible given the apparent state of the country’s finances but, yet again, this does not look like the action of a Party determined to break age-old shackles.

Following last week’s cut in interest rates and despite the Governor of the Bank of England categorically stating that this would not mark the start of a series of rate cuts, Sterling weakened considerably, only helped by the poor data from the U.S.

It fell to a low of 1.2727 on Thursday, only to recover to end much improved at 1.2805.

There is no tier-one data due for publication this week. This will allow the market to fully come to terms with the first rate cut since the Pandemic and judge the overall “state of play” regarding global monetary policy changes that have taken place or are still to come.

On the face of it, the July jobs data was a report that the market had been expecting for at least six months.

It was not horrendous and showed that even with interest rates at their highest level for decades and being kept at that level for an entire year, the economy can still thrive.

Unfortunately, the market won’t now allow Jerome Powell and his colleagues on the FOMC to cut rates “in their own time”, although that was always something of a pipe dream, given that a rate cut has to be determined by a weakening economy and driven by the data, especially when Central Banks are no longer prone as they were in the days of Bernanke and Draghi to act proactively.

The economy added 113k new jobs in July, with the unemployment rate rising to 4.3% from 4.1% in June.

Wages continued their downward path, with average hourly earnings falling to 3.6% from a downwardly revised 3.8% the previous month.

On the face of it, this looks suspiciously like the soft-landing Powell has been hoping for since the beginning of the second quarter.

Having just left interest rates unchanged, the pressure for a rate cut will now be ratcheted up several levels, but the FOMC has several further data releases to consider before a decision needs to be made.

The Fed Chair has been strident in his comments that it is the health of the overall economy, not just the level of job creation, which drives monetary policy.

No comments have been made yet by any members of the FOMC following last week’s meetings, so it is likely that the “usual suspects” will appear on the airwaves later this week.

ISM activity data is due for release later today, although it is expected that the weekly jobless figures due on Thursday will spark the most interest in a market that is amid its summer lull.

Last week, jobless claims rose above the critical level of 250k. This had been expected for some time, but in tandem with such weak jobs report led the market to believe that the economy is not on as sound a footing as was previously believed.

When the four-week average, currently at 238k, reaches a quarter of a million, alarm bells will sound just a little harder.

The dollar fell through several levels of support following the employment report. It reached a low of 103.13 and closed at 103.22. Further weakness is expected until the full picture of the convergence of interest rates becomes clear, but that may take several weeks.

Twas ever thus.

The ECB appears to be constantly in a growth versus inflation battle, which perfectly symbolizes the difficulty in setting monetary policy of such a diverse group as the twenty members of the Eurozone.

It has no recourse to the European Commission since Ursula von der Leyen seems to want to leave the tough decisions to Christine Lagarde and is far less “hands-on” than her predecessor Jean-Claude Junker.

Except for a single “blip” in June, the Governing Council has favoured tackling inflation allowing the economy to drift into recession on several occasions, either individually or “en bloc”.

Even though it is natural for economies that had made their own monetary policy decisions for decades before monetary union began with the abolishment of capital movement laws in 1990, to try not just inflict a “one size fits all” monetary policy on what has grown to be twenty nations is an impossible task made even more difficult by the lack of a fiscal union.

Inflation ticked up last month, and this will cause some anxiety among the more hawkish members of the Governing Council.

Isabel Schnabel, favourite to be elevated to Become the ECB’s Chief Economist, as the incumbent, Philip Lane, is favoured to become ECB Vice President, has spoken of her concern that inflation may not be fully controlled and if another rate cut is supported in September, it will lengthen the time it takes for price increases to reach the Central Bank’s target.

The opposite view is shared by both the Italian and Spanish Central Bank Governors who say that if rates stay unchanged, inflation may fall below the 2% target and drive the economy into recession.

Notwithstanding the unique systemic issues being faced by Germany, which appears to be unperturbed by the current weakness of its economy, overall, the Eurozone economy is “crying out” far lower interest rates to provide some support to consumers who are struggling with high levels of debt and exacerbated by the cost of living.

Last week, the Euro remained on the sidelines as a spectator as the Fed and Bank of England took centre stage.

On Friday, the single currency rose to 1.0926 and closed at 1.09912, erasing the losses it had incurred in the previous ten sessions.

Have a great day!