14 January 2025: Reeves is facing criticism from her colleagues

The Prime Minister announced another of his grand policy initiatives yesterday, this time extolling the virtues of Artificial Intelligence. Still, all his assembled audience wanted to know was whether Rachel Reeves had his full support as Chancellor of the Exchequer.

Keir Starmer announced the government’s AI action plan, promising to turn the UK into an AI superpower and use it to “turbocharge” the economy and improve public services.

The PM’s rhetoric was an attempt to soothe skittish markets amid a slide in the pound and a spike in government borrowing costs.

Starmer found himself in unfamiliar territory, having spent a significant part of the past year “preaching to the choir.” As Prime Minister, he now must justify comments made by his senior team, being faced with the prospect of whether to “back or sack.”

The Government must realize now that no matter what subject they bring reporters and commentators together to talk about, their audience will always choose the agenda.

Starmer used up one of his major policy statements by being diverted by questions about whether Reeves will still be Chancellor next year, let alone at the time of the next election.

After initially failing to guarantee her long-term future, Starmer insisted that Rachel Reeves will still be Chancellor at the next general election.

The Prime Minister’s official spokesperson said Ms Reeves would be in her post “for the whole of this Parliament” despite failing to make the same promise about Yvette Cooper, her Cabinet colleague.

His three most senior cabinet members Reeves, Cooper and David Lammy all have question marks about their long-term suitability to remain in position.

Lammy has been under pressure about remarks he said while in opposition about Donald Trump, while Cooper faces awkward questions about the allegations that have been made against fellow MP, Tulip Siddiq about her dealings with the Pakistani Government.

One Labour backbencher has commented that the only way Starmer can restore the Markets’ confidence is to sack his Chancellor. This is currently considered to be an unlikely outcome.

However, the longer Reeves defends her actions against a backdrop of market unease that is bordering turmoil, the more tenuous her position will become.

The Chancellor has flown back from China, with the cost of long-term Government borrowing hitting fresh highs and a sharp slump in the pound. She stood by her decision to travel to China to strengthen economic ties, even as rising government borrowing costs strain UK public finances.

She emphasised the importance of a long-term relationship with China, describing it as “squarely in our national interest.” Reeves announced that agreements secured during her Beijing visit would bring £600m to the UK over the next five years, although this should be set against the additional costs in interest payments as Government borrowing costs soar.

The pound reached its lowest level in a year, falling to a low of 1.2099, although it later recovered to close at 1.2176.

Towards the end of 2024, the market was fairly confident that inflation was moving squarely in a downward direction while the economy, and consumers, would benefit from lower interest rates as prices fell.

However, there has been a significant change in that perception as FOMC members, particularly those in the “permanent position” of Governors admit that while rates will be lowered throughout 2025, the cuts will be both driven by the data that is released monthly and the effect of the policies delivered by the new Administration.

Michelle Bowman and Christopher Waller, say rates can come down in a measured way if there is more progress in bringing inflation down to the Fed’s goal of 2%.

The two offered their views in speeches last week. Both voted for the Fed’s December decision to trim its key short-term Federal Funds Rate to a range of 4.25% to 4.5%. In the summer of 2023, the rate was 5.25% to 5.5%.

However, long-term bond yields have increased as the Fed cut the Federal Funds Rate as part of global concerns, kicked off by the UK’s borrowing plans, and continued in both the U.S. and Germany.

Bowman notably dissented from the Fed’s September rate-cut decision to 4.75% from 5%, which was its first rate cut in the current cycle since 2020. That dissent was the first in any Fed rate decision in 20 years. Bowman worried that the September rate cut was too big and risked reigniting inflation.

Fed Chair, Jerome Powell, supports his FOMC members discussing alternative views to the majority of the Committee but must accept the flak when those create unease and confusion in the market.

Although Donald Trump campaigned on a platform of introducing tough new tariffs on U.S. imports, repatriating undocumented immigrants and even greater deregulation of the Federal Government, what he finds when he arrives at the White House next week may be less onerous than he predicted in his campaign.

Nigel Farage, when being interviewed last weekend, said that he believed that the assassination attempt had brought forward a new calmer approach from Trump, one that may well lead to a more considered approach to his Presidency.

Doubtless Trump will be as tough in foreign policy announcements as he has always been since that is the cornerstone of his “Make America Great Again” rhetoric, but the economy is performing more than adequately and if he starts haranguing the Fed to cut rates, he will stand accused of fuelling the flames of inflation.

Inflation data for December is due to be published tomorrow with the market expecting a slight rise, from 2.6% to 2.7% in the headline rate while the core falls from 3.5% to 3.4%.

This is likely to be sufficient to encourage the Fed to leave rates unchanged at its January meeting.

The dollar continues to garner support from the perception that monetary policy will continue to diverge between the U.S. and Europe, as well as fears about the effect of the promised package of tariffs likely to be unveiled in the next couple of weeks.

The index rallied to a high of 110.18 but ran into selling pressure which pushed it back to close at 109.61.

The ECB was quite confident that inflation was “on the run” as it continued to cut rates towards the back end of last year. However, as ECB Board Member Isabel Schnabel said recently, the “final mile” towards achieving the 2% target rate for headline inflation would be the hardest of all.

It has been noticeable that the hawks on the Bank’s Governing Council have been making their voices heard again, during the final quarter of last year, those voices had been permanently quietened.

Robert Holzmann, The Governor of the Austrian Central Bank and one of the more vocal voices against wholesale rate cuts said recently that he doesn’t see any interest rate hikes now. “What could happen, though, is that one takes more time until the next interest rate cut.”

There are signs of an upward trend in some energy prices. But there are other scenarios as to how inflation could return, like via a further devaluation of the euro.

Holzmann, who is widely regarded as the pre-eminent hawk on inflation, was also asked about the prospect of incoming U.S. President Donald Trump imposing trade tariffs, and how that could affect economic growth, price pressures and monetary policy.

“A likely scenario is that Trump’s tariffs lead to an overall slowdown in growth but also create inflationary pressure. More so in the U.S. than with us,” Holzmann said.

“How strong the effect will be depends crucially on whether and how much the dollar appreciates and the euro depreciates.”

The Eurozone is set to see a weak start to 2025 after likely stagnating at the end of last year, according to analysts at Barclays. There are “no signs of recovery” in the currency area’s manufacturing sector in December, with traditional powerhouse Germany in particular showing “significant” sluggishness, while surveys also indicated a decline in confidence among both businesses and consumers.

Speaking to an Austrian newspaper on Monday, ECB Chief Economist Philip Lane said the ECB can ease policy further this year but must find a middle ground that neither induces a recession nor causes an undue delay in curbing inflation. The ECB cut interest rates four times last year, and markets see another four steps in 2025.

If interest rates fall too quickly, it will be difficult to bring services inflation under control. But we also don’t want rates to remain too high for too long, because that would weaken the inflation momentum in such a way that the disinflation process would not stop at 2%, but inflation could materially fall below target,” Lane added.

The euro has indeed continued its seemingly certain progression towards parity with the dollar, although there were signs yesterday that there may be some latest buying interest as it approached its medium-term target.

Yesterday, it fell to a low of 1.0177 and closed at 1.0216.

Have a great day!