23 December 2024: Reeves’ budget has had a worse effect than Kwarteng’s

According to the Confederation of British Industry, Rachel Reeves is close to driving the UK economy off a cliff.

When the Labour Party was elected in July, it wooed the electorate with promises that they would “make a difference”. Gone would be the confusion created by the Conservatives, the sleaze, and taxes would not be increased.

Less than six months later, the confusion has been replaced by a feeling that the Government is working on a plan that hasn’t been thought through thoroughly enough or costed as they promised.

The rise in Employer’s National Insurance Contributions is widely considered to have shown their promises about tax to be “sleight of hand”, while pensioners believe that they have been let down, with the removal of the winter fuel payment for all, and the backtracking over a promise to compensate WASPI women.

Farmers are outraged over a decision to charge inheritance tax on the change of ownership of family-owned farms, which could see many broken up and sold.

The economy, which was showing signs of recovery in the first half of the year, is likely to move towards a recession early next year.

The economy may not be in as bad a state as the evidence currently shows, but the perception that The Prime Minister, His deputy, and the Chancellor are creating does nothing to instil confidence that things are going to improve next year.

The UK economy is “headed for the worst of all worlds” as businesses expect activity to fall at the start of next year, according to the Confederation of British Industry (CBI).

The industry group’s growth indicator survey found that private sector firms expect to cut down on hiring, reduce output and for prices to rise in the first three months of 2025.

Alpesh Paleja, the CBI’s interim deputy chief economist, said: “There is little festive cheer in our latest surveys, which suggest that the economy is headed for the worst of all worlds, firms expect to reduce both output and hiring, and price growth expectations are getting firmer.

The Bank of England’s Monetary Policy Committee paused its cycle of rate cuts last week as inflation is not falling as had been expected, even though the economy is beginning to stagnate. The fear is that growth will disappear entirely while inflation continues to rise.

Economists talk of stagnation, but their views relate mostly to the theory, since, in practice, the circumstances that lead to it are exceedingly difficult to create.

Labour may have found the answer to that dilemma, by raising taxes while making what appear to be impossible demands on businesses of all sizes.

It remains to be seen if the UK will be subject to the threatened tariffs that the President-elect may introduce, so their effect is difficult to judge.

Sterling lost further ground last week as the Fed made what the market called a “hawkish cut” in interest rates. At one point it fell below its short-term support at 1.2475 but recovered to close at 1.2572.

Last week’s rate cut appears to be Jerome Powell “playing to the crowd. Deciding to cut rates by twenty-five basis points, while providing the market with a hawkish scenario, will confuse traders and investors.

It may well be that rates remain on hold for the entire first quarter of 2025 since inflation is set to remain sticky and the incoming Administration will do little to allay any fears that it has reached the limit of how low it can reach in the current environment before the economy begins to falter.

Suppose the core rate is say, 3%, or even marginally lower in March and the payrolls figure has been slowly moderating over the first couple of months of the year, to an extent that it may be about to turn negative. Will the FOMC be brave enough to cut rates then even as one of their two mandates are not being served?

Having had a simple task throughout the second half of this year, Powell may be reflecting that rate cuts, particularly the fifty-point cut that was seen in September, may have been a little premature, if not outright wrong.

The economy is doing better than most economists predicted a few years ago. Forecasters widely warned that the Fed would seriously harm the economy as it tried to control runaway inflation by sharply raising interest rates in 2022 and 2023.

Instead, price increases have come down substantially without a broader implosion. The unemployment rate is low. Consumers are spending.

“The US economy has just been remarkable,” Fed chairman Jerome Powell said during a news conference on Dec 18, after the Fed cut rates for a third time in 2024.

But a variety of risks – some sheer happenstance, some floated by Trump – could interfere with that rosy outcome just as the newly re-elected president takes office.

The “last mile” in bringing inflation down to the Fed’s target appears to be on the verge of being ignored. Whether that is deliberate or not depends on the market’s perception.

If investors are prepared to accept the work that the Fed has done in cutting inflation from close to double figures to where it is now, fine, but if prices begin to rise again, there could be trouble on the horizon.

The final month of the year has been as volatile as any in recent history, and the inauguration of the 45th President is likely to create a chaotic start to 2025.

There are no speeches scheduled from FOMC members this week given the holidays, but the market will want to know how Regional Presidents feel about the timeline for rate cuts to restart.

The dollar index received a significant boost despite the rate cut, due to Powell’s openly hawkish statement.

It rallied to a high of 108.55 last week but moderated on short-term traders’ taking to close at 107.80.

After years of living in the shadow of its northern neighbours, Spain is now showing a level of growth and activity that can only be admired by France and Germany.

A relatively calm political situation coupled with a significant boost to tourism post-pandemic has seen Spain set to lead, buoyed by industrial expansion, robust consumer spending, and labour market reforms that favour long-term employment contracts.

These changes have boosted job creation without sacrificing productivity, placing Spain ahead of major Eurozone economies like Germany, France, and Italy.

Spain’s economic resilience is further supported by reduced household debt, now at 85 per cent of income compared to 128 per cent in 2012, along with a shift to fixed-rate mortgages that mitigate the impact of monetary policy changes.

Germany, however, is still a weak link, with growth expected to stagnate at just 0.4 per cent year-on-year in the first quarter of 2025. Structural challenges, such as an ageing workforce, political inertia, and an outdated economic model reliant on exporting medium-innovation products, continue to weigh heavily on Europe’s largest economy.

Spain will “slip through Trump’s net”, not being too adversely affected by the introduction of tariffs on its exports to the U.S.

Spain exports around four hundred billion euros worth of goods a year, with the U.S. accounting for just around fifteen billion euros. So, Spain can fly under Trump’s radar.

Earlier in this quarter, the ECB was said to be considering cutting rates at every meeting until the end of the first quarter. There has been a slightly hawkish shift more recently as deflation has slowed. While the cycle of rate cuts remains in place, there may be one or two pauses early in 2025 to allow the economy to “catch up”.

The European Central Bank should cut its key interest rate only gradually while paying close attention to economic data for signs that inflation is reviving, executive board member Isabel Schnabel recently said.

Her remarks will resound through the EU’s capitals since inflation is still the “bogeyman” which hasn’t been entirely eradicated.

Schnabel’s colleague, ECB Chief Economist Philip Lane, is concerned about the unknown effect of the possibility of tariffs on EU exports to the U.S., although they are more likely to slow growth than increase inflation.

Lane agreed that there were scenarios in which inflation would slow because of higher tariffs, but also scenarios in which it would accelerate, with currency movements affecting the eventual outcome.

“We do think it’s negative for output and the impact on inflation is uncertain,” Lane said of “trade frictions” in a webcast last week.

The Euro ended the week significantly lower as the market expects the divergence in monetary policy to continue.

It fell to a low of 1.0343 but recovered to close at 1.0428.

Have a great day!