10 January 2025: Reeves could be forced to quit

It is more than a little glib for the right-wing UK press to blame the rising cost of borrowing at the Chancellor’s door when at least part of the issue is the global nature of government bond markets.

While the level of additional borrowing, seventy billion pounds a year, is within the parameters that Rachel Reeves set in her budget last Autumn, she is in danger of breaking her limits.

However, how she contains the issue, which has still not reached a critical stage, will determine her future. She is in no danger of being sacked by the Prime Minister, who has backed her at every stage, so unless the situation “boils over” into a full-scale crisis she should be able to survive.

The Chancellor travels to China to boost trade and economic ties, as she faces pressure over government borrowing costs hitting their highest level in years. The three-day visit has been criticised by some Conservatives who claim she should have cancelled the trip to prioritize dealing with economic issues at home.

It may be as well that she will be able to observe how the matter unfolds from afar. Upon her return, she will face some difficult choices that may force her to backtrack on one or more of her pledges.

She may decide to increase the self-imposed borrowing limit, which she has previously said was sacrosanct.

Based on the OBR’s October 2024 forecast, PSNFL is set to peak at 84.2% of GDP in 2026/27. This means the government was on track to meet this rule several years ahead of its current deadline of 2029/30 when it will have fallen to 83.4% of GDP.

The government was forecast to have more headroom against this rule, £16.9bn, than for the current budget rule.

Cutting public spending or raising taxes again are other choices. Neither will be comfortable nor well-received.

However, the increase in borrowing costs if it were to become permanent to even fall by a small amount would make the targets almost impossible to achieve. One pound in every twelve spent by the government is paid in interest on its borrowings. As things stand, that statistic is set to get significantly worse.

The pound has been considerably affected by the growing crisis. It fell to its lowest level since last April yesterday, falling to a low of 1.2238, but recovered to close at 1.2310.

Comments by the chief secretary to the Treasury, Darren Jones, later Thursday appeared to calm the market. He told the House of Commons that “gilt markets continue to function in an orderly way”, suggesting no need for emergency measures. Gilt yields eased afterwards, reversing the day’s gains.

The December employment report is due to be released later today, with the market expecting to study the report, considering this week’s FOMC minutes to understand how two of the most significant factors affecting the U.S. economy “marry up”.

In a little over a week, Donald Trump will return as President. This is creating a considerable amount of volatility in markets.

From Nuuk to Panama and from Gaza to Kyiv, Trump’s inauguration will affect the lives of millions, possibly billions of people. His threat to impose sanctions on countries that export finished goods to the U.S. is the great imponderable.

It is now inconceivable that some form of sanctions won’t be introduced, but the scale of those measures is the subject of a large amount of debate.

When the idea was originally floated, Trump threatened what appeared to be blanket sanctions across the entirety of America’s trading partners. He then “homed in” on China, Canada and Mexico and used the threat to get those countries to make concessions over migration and illegal exports.

Last week, he appeared to be looking to target specific sectors, like EVs and pharmaceuticals which the U.S. sees itself as a world leader but is being threatened.

Canadian Prime Minister Justin Trudeau resigned earlier this week, citing one of his reasons for leaving, the threat of the annexation of his country by the U.S.

Trudeau told CNN yesterday that U.S. President-elect Donald Trump’s annexation threats are a distraction from the damage a trade war with Canada would have on the American economy.

Trump has been taunting Trudeau online, calling him Governor Trudeau, and hinting that Canada is destined to become the 51st state.

While the threat has been made tongue-in-cheek, other threats, particularly to Greenland and the Panama Canal, are being taken very seriously.

Today’s data is being considered similar to the average of 2024 and is expected to come in at around 160k new jobs created. Many observers believe that at some point, the NFP data will prove to be a catalyst for the beginning of a downturn in the economy, but other data still points to a robust outlook.

The unemployment rate is expected to remain around the 4.2% level. In the past, anything below 5% was close to full employment, which has changed given how the jobs market has developed in the past few years, but many believe it to be a good “rule of thumb”.

The dollar index is still strong following the FOMC minutes, which were borderline between dovish and hawkish. The Greenback will be driven by any further Trump comments in the run-up to his inauguration.

Yesterday, it rallied to a high of 109.37 and closed at 109.17.

Several ECB Governing Council Members believe that inflation, which has been slowly rising over the past couple of months, will gradually recede again as the economy adjusts to lower interest rates.

December’s rise comes after inflation in the 20-nation single currency area fell to a three-year low of 1.7 per cent in September. Consumer prices have since been inching back up to above the ECB’s target of 2.0 per cent, the exact figure hit in October.

Eurozone retail trade inched up in November, although a slowing economy and low consumer confidence could upend a sustained revival ahead.

Despite the uptick, retailers could face challenges in the months ahead as the bloc’s economy slows. The European Commission’s key gauge of consumer confidence fell again in November to its lowest point since the spring.

Political developments in Germany and France, the two largest eurozone members, could also give consumers pause over whether to make large purchases. Germany, whose economy is expected to have declined for the second year in a row in 2024 and will go to the polls in February, saw retail sales decline 0.6% on month in November, according to Eurostat.

Import tariffs proposed by the incoming Trump administration in the U.S. could exacerbate geopolitical concerns affecting trade already seen in the Middle East and neighbouring Ukraine.

November’s data underlines that the retail sector’s recovery following the pandemic has been disappointing, with sales remaining well below their pre-pandemic trend.

Euro area government bond yields reached new highs yesterday, influenced by persistent service inflation and a sell-off in UK gilts.

Fiscal challenges are set to dominate euro area bond markets, as the impact of global yield increases and the recent UK gilt sell-off are analysed. Strong bond supply is leading to weaker prices and higher yields, with German and Italian bond yields experiencing only slight increases.

Less than 24 hours after Donald Trump was elected President of the United States in November 2024, the German state-owned news service Deutsche Welle published an article with the headline “Trump’s election victory is a nightmare for Germany.”

A few hours later, Germany’s chancellor, Olaf Scholz, announced that his three-party political coalition had collapsed. Disagreements about how to help strengthen Germany’s weak economy were a major factor, but Scholz mentioned that the U.S. election outcome also fuelled the coalition breaking up.

One month later, Scholz lost a confidence vote, ending the government he has led since 2021. Germany will have federal elections on Feb. 23, 2025.

Germany is considered one of the United States’s closest allies in Western Europe, partnering on everything from economic trade to military defence.

How Trump deals with Europe, particularly the NATO budget, will have a significant effect on how Germany recovers from two years of decline.

The euro is still suffering from perceptions of greater divergence in monetary policy.

Yesterday, it fell to a low of 1.0283 but is attracting some buying interest below the 1.03 level, which saw it recover marginally to close at 1.0311.

Have a great day!