28 October 2024: Reeves admits her Budget will be “tough”

It feels like Rachel Reeves’ first Budget as Chancellor, which she will present to Parliament on Wednesday, has dominated the Government’s agenda since it was elected in July.

Right-wing commentators and Conservative MPs believe that Reeves’ proposals will seal Labour’s betrayal of the electorate by reversing several of its manifesto pledges.

The Chancellor will confirm the means-testing of the Pensioner’s winter fuel allowance, increase the employer’s National Insurance contributions, and retain the “two-child” benefit cap.

While nominally sticking to the election pledge of no tax increases for “working people” the Prime Minister tried and failed to reassure the electorate on what exactly defines a working person.

Businesses are concerned that the increase in National Insurance, a rise in capital gains tax, coupled with an unlikely but entirely feasible increase in Corporation Tax, will hit growth and investment, two words that have become bywords for Sir Keir Starmer.

A rise in the cap on fuel duty will increase the forecourt price of Petrol and diesel. The gradual fall in energy costs has been the singular most important reason for inflation having fallen to reach the Bank of England’s target over recent months.

There are sure to be the “normal” budget tax increases on tobacco and alcohol, while SMEs fear the removal of the Business Asset Disposal Relief. Albeit, that would not result in a significant tax increase for the Treasury. Some of the potential changes to Capital Gains Tax could lead to a tax revenue loss, as they may encourage business owners and investors to retain assets.

Bank of England interest rate-setter Catherine Mann, speaking in Washington, welcomed a recent fall in inflation, but said the cooling of price growth still had “a long way to go” for the central bank to hit its 2% inflation target over the medium term.

To get to a target consistent with a 2% inflation rate, services still have a long way to go,” she said in a panel discussion on the sidelines of meetings of the International Monetary Fund.

Asked during the panel discussion about her stance on rates now, Mann said: “If you have structural persistence in the relationship between wages and price formation that is persistent and embedded, then it’s premature to start cutting until you purge those behaviours.”

The pound was under pressure for most of last week as the divergence of monetary policy between the UK and the U.S. gained the market’s attention. It fell to a low of 1.2941 and closed at 1.2950.

The Presidential Election is a little over a week away and irrespective of the result there is sure to be increased volatility, possibly bordering on turmoil in the financial markets.

If Kamala Harris is declared the victor, there is almost certain to be several challenges to the result from Donald Trump and his advisers. It may well be that similar scenes of insurrection in Washington will be seen in the last election, in which Trump was accused of “whipping up” his supporters into a frenzy of outrage which almost swamped the Capitol.

However, if Trump were to be declared the victor next Wednesday, the effect may be less physically violent, but it may provoke similarly nominal violence in the financial markets.

Several G7 commentators have expressed concern about his threat to attach tariffs of between 30% and 200% on several U.S. imports, ranging from high-tech parts from Asia to electric vehicles from Europe.

Domestically, importers are preparing for such an eventuality by increasing orders for imported items which they expect to attract tariffs.

The Federal Reserve may well be less inclined to signal a further interest rate cut at its meeting in a couple of weeks until voting members of the FOMC have had a chance to evaluate the inflationary effect of any measures.

Should Trump be victorious, it will see the end of the highly successful partnership between Treasury Secretary Janet Yellen and Fed Chair, Jerome Powell.

Yellen has already been sacked once by Trump. She preceded Powell and is certain to be replaced as Treasury Secretary.

Powell, who always appears to be sanguine or indifferent about his longevity in the role, has been criticized on several occasions by Trump, despite overseeing the fall in inflation to its current level, close to the Fed’s target of 2%.

This week will see the publication of the October Employment Report, which will begin the third quarter’s release of data for the economy.

The Fed has faced criticism for cutting rates by fifty basis points prematurely in August since it was unaware that the headline number of jobs created would be the third-highest on record.

The FOMC may be a little more circumspect on November 7th given the economic data which shows that the economy is currently healthy despite fears that there may be a recession in the next 12–18 months.

The Dollar index has continued to see healthy gains, although it is beginning to run into some selling interest ahead of the election.

Last week, it rallied to a high of 104.57 and closed at 104.31

Christine Lagarde’s current preoccupation is with global trade, and more specifically the threat of Tariffs being introduced should Donald Trump win next week’s election.

She has warned that rising trade restrictions could drag inflation back to life and hit the global economy hard. Also speaking in Washington, Lagarde made it clear that international cooperation is not just a “nice-to-have.” She believes it is “crucial” if we want global growth to stay on track.

“Legitimate concerns about security and supply chain resilience can’t push us toward a spiral of protectionism,” she said.

She added that more trade barriers could make everything pricier by jacking up costs for businesses that rely on imported materials and narrowing the pool of suppliers. This, she pointed out, would tie the hands of central banks when trying to manage inflation.

Global trade barriers have been quietly stacking up over the past decade, fuelled by growing mistrust. Major economies are not too eager to lean on one another for critical goods like semiconductors, especially from countries with tense diplomatic ties.

And since Russia’s invasion of Ukraine, the world has only seen more of these issues pile up. The ECB’s economists have calculated that if countries start throwing up barriers around “strategic products,” we could be looking at a GDP loss equivalent to 6% globally.

Inflation was revised down to 1.7% in September, way below the ECB’s 2% target and a huge drop from the 2.2% seen in August.

Mario Centeno, Head of Portugal’s Central Bank, recently said that “the truth is that the print of inflation in September was very low, way lower than what we were expecting.”

And while Centeno sees some room for cautious optimism, he left the door open for a bigger rate cut. “After that, we need to look at the incoming data,” he said, hinting that a 50-basis-point cut could be on the table in December if the data backs it up.

Dutch ECB Governing Council member Klaas Knot shares this view. “A half-point interest rate cut could not be excluded,” he said, though he added that this would hinge on the data pointing toward a downturn.

Knot even suggested that the ECB might be close to hitting its 2% target next year, but the data would have to back that up in December. He described the scenario as one where the ECB could “gradually take our foot off the brake” and inch toward a neutral rate where they are not stimulating or slowing down the economy.

Members of the ECB’s Governing Council were taken aback by the significant fall in inflation in September. While there may be some “technical” reason for such a large drop, Philip Lane, the Bank’s Chief Economist, believes that the three rate cuts recently have not particularly affected the inflation outlook, and it will still be six months before the ECB can be confident that inflation has been tamed.

The Euro is suffering from the market’s view that the G7 monetary policy is diverging rapidly and that it will continue for at least the next quarter.

It is dangerous for the market to believe that euro weakness is a one-way bet, and there may well be one or two major corrections before the market settles down.

Last week, the single currency fell to a low of 1.0761 and closed at 1.0795.

Have a great day!