10 July 2024: Haskell demands rates stay elevated

Before the election, Labour’s bywords were “change and trust”. Having romped home comfortably, those bywords have been distilled down to “growth”.

The IMF has reconfirmed its prediction that GDP growth this year will be 0.7% and 1.5% in 2025.

It is unclear what level of growth is needed to generate sufficient tax revenue for the new government to fulfil its manifesto commitments over the first two years of this Parliament without raising taxes or increasing borrowing.

Economic growth in the country is recovering faster than expected after a mild technical recession in 2023.

Inflation, meanwhile, has fallen rapidly to the near-term target from last year’s double-digit levels due to the reversal of the energy price shock and the demand impact of tight monetary policy, it added.

Inflation is expected to temporarily increase from around 2% now to 2.5% by the end of this year because of regulated energy price base effects, but it is forecast to return to 2% in early 2025, according to the IMF.

The new Health Minister, Wes Streeting met with representatives of Junior doctors yesterday and both sides said afterwards that the meeting was “constructive”.

Junior doctors have demanded a 35% increase in their pay, which the previous Government said was unreasonable and unaffordable. The junior doctors’ representative commented following the meeting that the claim was not dismissed, which was a positive, while the Health Ministry team said that no numbers had been discussed.

The only positive outcome of the meeting was that it took place at all.

Following his first speech as Prime Minister, which received a rapturous greeting from Labour MPs, The Prime Minister has flown to Washington to attend a NATO summit where his first foreign policy pledge, for defence spending to be increased to 2.5% of GDP, will come under the microscope.

In Parliament, Rishi Sunak, for now, the Leader of the Opposition, cut a hugely different figure from the Prime Minister. Chastened, Sunak tried to appear humble, but it was not a look that he was used to.

Bank of England Monetary Policy Committee member Jonathan Haskel revealed he is likely to vote to hold rates at the current 5.25% level at the next meeting in August.

Following a six-week gap due to the election, Haskel spoke of his opinion that inflation will likely remain elevated for quite some time. His views run contrary to those of the IMF. He blamed the current elevated level of wage settlements, which may take the rest of the year to abate.

The pound lost ground yesterday as it returned to its pre-election range. It fell to a low of 1.2777 and closed at 1.2786. Versus the Euro, it also retreated, making a low of 1.1819 and closing at 1.1825.

In his semi-annual testimony before the Congress Finance Committee yesterday, Fed Chairman, Jerome Powell, wanted to remain hawkish on inflation but also saw the sense in acknowledging the progress that has been made in driving the level of price increases down.

This was not the time to be looking forward, since his testimony is a review of what has taken place in the past six months.

He therefore did not predict when the FOMC may be comfortable to loosen monetary policy, although he did comment that inflation is coming under control.

Powell indicated the Fed was now turning its focus to the labour market, where consideration must be given to how elevated interest rates can result in unnecessary job losses. There is no question that the employment market is cooling.

This is clear from the number of jobs that were created in the second quarter compared to the first.

Reducing policy restraint too late or too little could unduly weaken economic activity and employment. In other words, Powell believes that the FOMC needs to remain Data dependent.

In short, Powell believes that the threats to the economy from Inflation and growth concerns have become more balanced.

There is concern that the Fed’s “laissez-faire” attitude to cutting interest rates may have to change.

If rates are cut too soon, before inflation is truly tamed, Powell is concerned that there may be another “burst” of price increases similar to what was seen in February and March.

The market will go through its summer lull quite soon, and it is expected to await Powell’s appearance at the Jackson Hole symposium in late August to get any warning about a September rate cut. However, The Fed Chair will likely remain guarded in his comments.

The dollar is unlikely to be driven far from its current range due to comments from Fed officials. Events in Europe, both economic and political, may provide some volatility.

Yesterday, the dollar index gained for the first time in six sessions, rallying to a high of 105.21 and closing at 105.13.

Italian ECB Governing Council Member Fabio Panetta believes that the Central Bank no longer needs to be concerned about causing a spike in inflation since price rises are “well controlled”.

The reduction of official rates can proceed gradually, accompanying the return of inflation towards the objective, if macroeconomic trends remain in line with the ECB’s expectations, Panetta, who is governor of the Bank of Italy, told bankers at a conference in Rome.

The two major concerns about inflation are wage growth and services costs. In data released this week, wage costs rose marginally, but nowhere near the rate at which they had been rising in recent months.

Italy has previously been at the forefront of calls for interest rate cuts, since its economy has been used, over many years, to deal with inflation shocks.

Panetta’s colleague, the Italian Finance Minister, Giancarlo Giorgetti, speaking at the same conference, spoke of his concern that any further contraction in demand due to continued high interest rates would stifle the economy and snuff out its recovery.

The French economy is facing up to the threat posed by the radical policies proposed by the far-left victors in Sunday’s legislative election.

Jean-Luc Mélenchon and his New Popular Front colleagues have proposed an income tax rate of 95% on earnings over Eur 400k and a reduction in the official retirement age to 60 from 64.

This is a reversal of President Emmanuel Macron’s retirement age increase, which caused such anger amongst the electorate last year.

With the French budget deficit and debt-to-GDP ratio significantly above the ECB guidelines already, Melenchon is driving the economy towards a conflict with Brussels and sanctions from the ECB.

The NFP are anti-capitalist and anti-European, as they want to leave the Stability and Growth Pact and international free trade agreements, while the National Rally is no longer openly displaying anti-EU views. Their Platform was Islamophobic, which was what galvanized the Left.

Political turmoil will likely exist in France right through the Summer, although the Paris Olympic Games will provide some distraction.

The Euro is now trading back at the level at which it started the election weekend. Yesterday it fell to a low of 1.0805 and closed at 1.0813.

With political events and monetary policy driving activity, and many market professionals about to begin their summer holiday, a lack of liquidity may lead to some sharp reactions.

Have a great day!