11 May 2023: Sunak warns of an eighty billion hole in Labour’s plans

Yesterday’s Prime Minister’s questions in the House of Commons may have seen the first stage of a fightback from the Rishi Sunak, who has been forced to simply listen as the Labour Party have gone about outlining the policies they would enact when, not if, they wing the next General Election, such was their lead in the opinion polls.

Last week’s local election results were, no doubt, disappointing for the Conservative Party, since they pointed to Labour winning the most seats in a General election. However, voter apathy played a large part in the turnout, while the results also predicted that while Labour would be the largest Party in Westminster they may not have an overall Majority.

Having listened to several weeks of Labour criticism, Sunak apparently realised that it was time for a fightback.

He railed upon Labour leader, Sir Keir Starmer, challenging his assertion that all his Party’s spending plans had been fully costed and were affordable without increasing public spending.

He criticised Labour celebrations, calling Starmer cocky, before asserting that at a General Election, policy counts. This is the first salvo in what is likely to be a long-winded battle that will last right up until Sunak announces the date of the next general election which has to take place before January 2025.

The IMF has been forced to backtrack over its gloomy predictions for the UK economy. News forecasts point to a period of unrivalled strength for the pound.

Citibank was the first to change its predictions after an economic boost backed by services output and a housing market which is proving to be far more durable than had been expected, even though several hundred thousand mortgage holders will see the cost of their home loans increase as cheap deals expire.

Citi had predicted that house prices would collapse and sterling would fall to parity versus the dollar. In their latest economic bulletin, they now predict that the pound will rise above 1.30 versus the Greenback.

This forecast has been echoed by analysts at NatWest and Goldman Sachs.

The result of today’s meeting of the MPC is being treated as the foregone conclusion it is likely to be. However, any hint of a pause in rate hikes from Andrew Bailey in his press conference following the meeting will have an effect on the Markets. Given the new-found positivity, Sterling may not suffer too badly should a pause become likely at the next meeting.

The pound rose to a high of 1.2680 yesterday but ran out of steam as traders waited for today’s announcement. It fell back to close at 1.2626.

The inflation report for April had some good news for the Fed as the headline fell below 5% for the first time in over a year. Although the fall in prices was small, it was sufficient to possibly confound the words of New York Fed President, John Williams, who had haunted at more rate hikes in a speech the previous day.

While the Fed is playing catch up Jerome Powell’s words allow the economy to react in full to the fed funds rate reaching 5% and almost certainly becoming restrictive on demand.

Having hiked rates at every meeting since last Spring, the Fed will closely observe data released between now and its next meeting on June 14th, which will be the last of this quarter.

If output and productivity hold up well and the May employment report points to a soft landing for the economy, the Central Bank may indeed find a degree of justification in its decision to end its cycle of rate hikes.

It has been seen several times over the past few years, but there is a different feel to the threat to the U.S. economy that may come from a failure by Congress to increase the debt ceiling and allowing the country to default on its debt as The Federal Government quite literally runs out of money.

The negotiations that are taking place in Congress currently hold no certainty of success and the clock is ticking down. There are now only three weeks to go before what Treasury Secretary, Janet Yellen calls a catastrophe.

If the U.S. were to default, its effect would be felt in every corner of the world. The Democrats want a deal to be done as quickly as possible, while the Republicans, goaded by former President Trump, want a number of spending cuts to be agreed before any vote is taken.

As always, the debt ceiling is turning into a high-stakes game of chicken, as it remains to be seen which side will blink first.

While a pause in the tightening of monetary policy may come as soon as next month, no one is expecting the Fed to cut rates anytime soon. Although inflation has fallen considerably, it remains well above the Fed’s 2% target and until that happens any stimulus that would come from cutting interest rates will remain firmly off the table.

Yesterday, the dollar index lost ground following the publication of the April inflation report but remained in its current range.

It fell to a low of 101.24 and closed at 101.44

The IMF published a report on the state of Eurozone banks yesterday, having conducted a series of stress tests recently.

It found that while it feels that banks are strong and have sufficient capital and liquidity to deal with the current uncertainty that is happening as a result of three U.S. banks failing recently but remains concerned that they could be vulnerable if a credit crunch becomes more serious and lasts for an extended period.

One issue is the lack of progress that has been made over a banking union within the EU.

Every individual nation is currently responsible for its own banks while a banking union would guarantee every bank is responsible to a central entity. Brussels has so far been unable to find a common agreement since the amount of work that would be needed to ensure that the Government in say, Germany, has sufficient confidence in banks in say, Latvia, to guarantee its depositors.

The effect of the failure of the Silicon Valley bank and others was minimised to a large extent by having in place a Federal Guarantee scheme which quelled depositors’ fears. The lack of a banking union means that in a similar situation, California would be left to deal with the situation alone.

While there is no indication of any issues with the capitalization of Eurozone banks, the IMF noted a lingering fear regarding the length of time banks are given to allocating capital to bad and doubtful loans.

In general accounting norms allow five years for bad loans to be fully accounted for, but the EU currently allows eight. This is a throwback to the sovereign debt crisis.

Brussels has a habit of putting emergency policies in place that allow them to be accepted as part of the regulations. That is why there is some urgency being attached to the reinstatement of the Growth and Stability Pact, which was suspended during the pandemic and would currently be almost impossible to reinstate.

The Bank of Greece Governor, Yannis Stournas spoke yesterday of his personal view that the current round of rate hikes is coming to an end. In general, this would be seen by the market as yet another central banker talking his book, but the strides that Greece has made over the past few years in stabilising its economy, provide a certain degree of credence to Stournas’ words.

The Euro benefited from the market’s perception that some divergence of monetary policy between the U.S. and the Eurozone is about to happen.

Yesterday, the single currency rose to a high of 1.1006 but fell back to close at 1.0982 as it continues to struggle to make fresh highs.

Have a great day!