16 August 2024: Reeves may owe Hunt an apology

There is a significant degree of “crowing” in the right-wing press over the state of the economy that the new Government “inherited” from the Conservatives. Although she will never admit it, Rachel Reeves’ comment that the economy was in the worst state since the Second World War appears to have been “wide of the mark”.

The economy grew by 0.9% year-on-year in the second quarter, and inflation is hovering around the Bank of England’s target, allowing it to begin to loosen monetary policy.

Nadine Dorries may be able to write another expose cataloguing the reason Rishi Sunak called the election when he did.

A further benefit that Reeves has received from the level of growth that is currently higher than either the U.S. or any nation of the Eurozone is that she may not need to raise taxes in her Autumn Budget.

It may well be that the economy is currently performing at its “highest point” and some moderation may happen as Autumn turns to winter and energy bills begin to rise again.

But the Government can “make hay while the sun shines”.

This is just as well since a 15% pay increase for rail workers is almost a done deal, following significantly above inflation pay settlements for junior doctors, NHS staff and teachers.

In June, the economy flatlined, having seen a substantial improvement in April and May as the “Taylor Swift effect” was countered by poor weather and industrial action.

Household consumption was up as people got a few more pennies in their pockets thanks to falling inflation and strong wage growth. At the same time, the extra cash sloshing around has provided the fuel for the kind of growth that’s been lacking for the past couple of years when the economy seemed to flatline following its post-Covid recovery.

Next week will be a lot quieter with only output data due for publication as the market continues to speculate about whether the data that has been released so far this month warrants a cut in interest rates.

It seems likely that there may well be a change in at least one vote from cut to unchanged, which will tip the balance for the MPC.

The pound has had a strong week overall, which is fully justified by the data. Yesterday, it reached 1,2871 and closed at 1.2855 as the final push to reach the elusive 1.30 level appears to be eluding it.

Fed Governor Michelle Bowman has emerged as the most hawkish member of the FOMC, yet even she is allowing herself to consider an interest rate cut in the coming months, although she appears to believe that her colleagues won’t vote for a cut in September.

This would, in any case, be an unusual move for any Central Bank, but especially the Federal Reserve, since the clouds of a recession have largely gone away to be replaced by the blue sky of a soft landing.

She welcomed progress on inflation but felt that “more work needs to be done” before it reached the 2% target.

The economy is reaching an inflation point where inflation may not be able to reach 2% without the Fed risking a recession.

The President of the St Louis Fed, Alberto Musalem spoke yesterday of his view that the time is approaching when the Fed may be able to cut interest rates, although he is still of the opinion that cutting rates aggressively may see inflation “reignite”.

Musalem believes that monetary policy is still “moderately” restrictive, while services and housing inflation is still “sticky”. The July jobs report showed that the labour market is no longer overheating, although lay-offs remain low.

His colleague Patrick Harker agrees. The President of the Philadelphia Fed has been a constant hawk on monetary policy during his tenure on the FOMC, but he also believes that there is more work to be done.

Yesterday’s release of retail sales data finally put the fear of a recession to bed. They grew by 1% in July after a 0.2 decline in June. Jobless claims also in the latest reporting week.

With Labor Day, the traditional end of the summer lull still two weeks away, the market will be driven by speculation and the odd comment from FOMC members.

Yesterday, the dollar index recovered its poise as the market began to appreciate the comparative growth rates between the U.S. and the Eurozone.

The Greenback climbed to a high of 103.23 and closed at 103.03 as it attempted to put in place a medium-term bottom. While activity is still muted, there may be another attempt to achieve a new low, but overall, the dollar looks to have recovered from the July jobs data surprise.

In a report published this week, the ECB voiced its concerns that lenders are over-valuing the value of commercial real estate that is placed as collateral for lending.

The Eurozone’s leading banks may be inflating the value of commercial property, potentially obscuring the true state of their loan portfolios in a sector that is facing significant challenges.

The analysis suggests that some banks are failing to properly account for the steep downturn in the commercial property market, which has been severely impacted by higher borrowing costs and weakened demand as businesses adjust to the post-pandemic economic landscape.

Just as the economy has begun to show some signs of a recovery, although there is a long way to go, the spectre of another financial crisis is affecting investors.

One of the key findings of the inspection was that some banks are relying on outdated transaction data, using figures from 2021 or earlier to justify current valuations. This overlooks the significant changes in the market, including increased inflation and higher ECB interest rates, which have fundamentally altered the economic conditions since those earlier transactions.

The ECB has criticized the banks for not adjusting valuations, appearing to “bury its head in the sand” in the hope that the sector will recover. This has happened before, but in the government bond sector, this problem may be more common.

Some banks were found to be underestimating the impact of higher construction costs on new developments and accepting overly optimistic valuations based on the highest and best use of the property, rather than more conservative and realistic assumptions.

While this may be an issue that can be relatively easily contained, it highlights the need for the ECB to be supported in its multi-faceted role as arbiter of monetary policy as well as market watchdog.

Next week sees the release of preliminary purchasing managers indexes for July, and the market will be concerned that the services sector is no longer supporting the composite data.

Last month, services output was at 51.2, but it is feared it may slip much closer to the watershed level of 50. The manufacturing sector will remain in the doldrums, only showing a marginal improvement from the 45.8 level achieved in June.

Yesterday, the Euro saw the full extent of the market’s belief that it has been overvalued recently. Although a rate cut next month is “in the balance”, the parlous state of the economy may lead to a significant loosening of monetary policy in the Autumn.

Yesterday, it fell to a low of 1.0949 and closed at 1.0972.

Have a great day!