20 November 2024: Bailey believes that service inflation is too high

It is becoming clear that the Prime Minister and Chancellor badly misjudged the level of militancy that farmers are capable of when they decided to apply inheritance tax to farms with a value of more than a million pounds from April 2026.

There is a significant disagreement between the Government, which believes that the tax will only apply to around 500 of the more than 200k farms in the UK per annum, and the farmers who consider the true number exponentially higher.

More than ten thousand farmers brought their protest to London yesterday, calling for Rachel Reeves to reverse her decision.

It is well known that farming is an industry where its proponents are “asset rich but cash poor”, meaning that while their farms are of a high value, the margins they make from their businesses are tiny compared to other sectors of the economy. Therefore, to try to find 20% of a farm’s value when to pay the tax when it is passed down the generations is likely to lead to many farms being broken up and sold.

It is unlikely that Sir Keir Starmer and Rachel Reeves have heard the end of the farmer’s complaints.

Bank of England Governor, Andrew Bailey, spoke yesterday of his concern about the level of inflation that remains in the services sector of the economy. While the price of goods and foodstuffs has fallen as overall inflation has fallen, the cost of services such as banking and insurance has continued to increase.

One factor in this has been Rachel Reeves’ decision to allow so-called “bankers bonuses” to be further deregulated.

Bailey said yesterday that the 25-basis-point interest rate cut in November was justified as the pace of disinflation has been faster than expected. However, he noted that services inflation is still at a level that is not compatible with keeping inflation at a 2% target.

Bailey maintained that the BoE would adopt a gradual approach and assess risks to the inflation outlook as they become clearer. He did not offer firm predictions on the impact of the government’s budget, unveiled late last month, although he noted some of its measures could push inflation up.

He also pointed out that the United Kingdom’s import prices are “stronger than indicated by word export prices,” which is another upside risk to inflation, as are developments in the world at large.

Bailey’s colleague on the Bank’s Monetary Policy Committee Megan Greene commented that the United Kingdom’s new budget will cause inflation in the country to rise, as it has increased the cost of hiring for firms.

Greene also agreed with Bailey that while the service’s inflation is on a downward path, it is not falling at the speed she would like. She also spoke about wage growth, saying it might be “stickier than hoped,” with a risk of it reaching closer to 4%.

The pound continued its recovery from last week’s fall as it climbed to a high of 1.2689 yesterday and closed at 1.2677.

In the lead-up to the Presidential Election, Jerome Powell and his colleagues at the Federal Reserve made it clear to the markets that they were expected to be apolitical in their outlook and were unable to predict the effect of any particular outcome when deciding monetary policy.

Since the election and Donald Trump’s resounding victory, with the market in foment, the FOMC still must wait until Trump confirms new policies rather than anticipate their possible effect on the economy.

The relationship between Trump and the Fed Chair has been less than cordial over the past year, as Trump has used the Fed’s reticence to cut the Fed Funds rate while inflation was still perceived to be an issue, as a “stick to beat it with”.

Powell, speaking in Dallas this week, has “poked the bear” again by saying that such is the robustness of the economy that the FOMC can afford to be patient on future rate cuts, given the strength of the economy and the stubborn nature of inflation, setting up a potential conflict with the incoming Trump administration.

“The economy is not sending any signals that we need to be in a hurry to lower rates,” Powell said in prepared remarks to a business forum. “The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully.”

“Inflation is running close to our 2% goal, but it’s not there yet, and we are determined to finish the job,” he added.

Caution is not a word often associated with Donald Trump in any part of his life, business, political or personal, and he is not likely to hold back on his criticism of any move that, in his view, holds back growth and economic output.

Although some of his colleagues have referred to the possibility of the introduction of tariffs on U.S. imports of finished goods, Powell has so far chosen to wait until there is some “meat on the bones” of any proposals before commenting on their possible inflationary consequences.

Traders have sharply pared bets on a December rate cut, with the CME Index now pegging the odds at around 62%, down from as high as 85% late last month.

Despite a few dissenting voices on Wall Street, most commentators agree with Powell that the economy is still sufficiently resilient. The sharp decline in job creation that was seen in October has been absorbed into the market’s thinking, although another poor number for November would maybe tilt the balance.

Some months ago, Powell was quoted as saying that as long as job creation remained in positive territory, the FOMC would remain conservative in its loosening of monetary policy. There is a distinct possibility that November’s headline NFP may test the level of his conservatism.

The dollar index is still finding support following its recent minor correction. Yesterday, it fell to a low of 106.11 and closed at 106.18. Given the pace of its recent rally, it has leeway to fall to 105.50 yet remain in an upward trajectory.

Bank of Italy Governor, Fabio Panetta, spoke yesterday of his fears that inflation could fall well below the 2% target as demand remains stagnant. “The European Central Bank must commit to faster ECB’s interest rate cuts to lift the Eurozone economy,” he said in a speech in Milan.

The ECB must commit to faster interest rate cuts to lift the Eurozone economy. Panetta also urged officials to ditch their “meeting-by-meeting” approach to monetary policy.

The Bank has lowered interest rates three times this year, taking borrowing costs to 3.25 per cent, and is widely expected to make another quarter-point cut in December and further gradual reductions next year.

Analysts expect that the ECB’s key deposit rate will be lowered to about 2 per cent, generally considered a neutral point that neither expands nor contracts economic activity, by mid-2025.

According to Eurostat, inflation across the eurozone increased slightly from the 1.7% recorded in September.

When the wider EU is included, October’s inflation rate increased to 2.3% up from 2.1%.

The highest annual rates were recorded in Romania, at 5%, followed by Belgium and Estonia, both at 4.5%. Slovenia recorded 0% inflation during the month, while Lithuania and Ireland both recorded 0.1%. Eurostat said the highest contribution to the annual euro area inflation rate came from services, up 1.77%, followed by food, alcohol and tobacco, up 0.56%.

In general, ECB Governing Council Members have moved away from efforts to control inflation with even the most hawkish members of the rate-setting committee, like Robert Holzmann and Isabel Schnabel accepting that the time has come to cut rates to try to promote demand aggressively.

Europe will not be able to afford its generous welfare state provision and increased investment in defence and in tackling climate change unless the region fixes a persistent decline in growth, the European Central Bank’s president Christine Lagarde has warned.

Without bold economic policies, the EU “will not be able to generate the wealth we will need to meet our rising spending needs to ensure our security, combat climate change and protect the environment”, Lagarde warned in a speech in Paris.

The Bundesbank dampened any optimism about the country’s economic growth in its November monthly report, which was released yesterday. Although preliminary data indicated that German GDP grew by a surprising 0.2% from July to September, the Bundesbank said there was little evidence of an improved underlying economy or a trend toward growth.

According to the central bank, industry and construction will continue to dampen economic output. According to the report, high financing costs for construction and the pronounced economic policy uncertainty will continue to weigh on investment and push down demand for construction services and capital goods.

Although there are signs of a recovery in the export business, global demand for German-produced goods is still weak.

The Euro appears to have found a base around the 1.0500, although any progress is likely to be hindered by the expected rate of interest rate cuts and the possible introduction of tariffs by the Trump Administration.

The single currency rallied to a high of 1.0601 yesterday and closed at 1.0593.

Have a great day!