12 January 2024: Deutsche Bank sees UK inflation at 2%

It has emerged that the UK economy is currently around £140 billion smaller than it would have been had Brexit not taken place. A study by Cambridge Econometrics shows that by 2035, the “cost” of Brexit will have reached £300 billion.

The study also shows that there are close to 300k fewer jobs in London than there otherwise would have been.

Although the Government has paid a great deal of lip service to “levelling up” during this Parliament, the truth is that there continues to be a widening productivity gap between the Capital and the rest of the country.

The largest impact has been in the employment market has been in the Construction sector, while most of the economic impact is being felt in the finance sector as major banks and finance houses are relocating their corporate head offices to European capitals like Paris, Frankfurt, or Brussels.

On a brighter note, economists at Deutsche Bank estimate that headline inflation will fall to the Bank of England’s target of 2% this spring. This will supply further impetus to the growing calls for interest rates to be cut, which will in turn drive growth and encourage the jobs market.

The Monetary Policy Committee is unlikely to be swayed by such predictions, even if its economists concur since they still prefer to be reactive to data rather than proactive to predictions.

Today will see a raft of economic data published which will show if the economy exhibited any growth at all in the last couple of months of 2023.

Data for manufacturing and industrial output are expected to show a welcome degree of strength, each moving into positive territory, while the monthly GDP figures for November may well show that the economy grew by 0.2% following a 0.3% fall in October.

These figures will add to the level of optimism that the country escaped a recession last year, although many still believe that if the Bank of England does not cut rates soon, an economic contraction may still happen.

Next week, employment and inflation data will both be published. The Central Bank will be looking at average earnings, expecting them to have fallen, in line with the lower outlook for inflation.

Headline price increases are expected to see a marginal increase, but this will be offset by a similar fall in core inflation.

Sterling had another strong day yesterday, as speculation grew that the rate cuts may begin in the U.S. It climbed to a high of 1.2774 and closed at 1.2759. It is close to threatening medium-term resistance at 1.2780 but will need to gain further momentum today to break that level conclusively.

The reason that the market is paying such close attention to comments made by Central Bankers about interest rate cuts is the fact that there is a far greater degree of agreement from members of the FOMC, which is not evident in the MPC, while the ECB seems to see significant differences between its members over the future path of interest rates.

Yesterday, Austen Goolsbee, the President of the Federal Reserve of Chicago, spoke of his view that 2023 was a “hall of fame year” for tackling inflation and if that trend continues rates will be able to be cut roughly in line with the market’s expectations.

Comments from FOMC members since it confirmed the end of its cycle of rate hikes have been far more coordinated than has been seen in other G7 nations over a similar period.

In the grand scheme, all G7 Central Banks decided that interest rates in their jurisdictions had become sufficiently restrictive at roughly the same time.

Different start times with the Bank of England beginning then the FOMC, and finally the ECB, since it was concerned about post-pandemic support, the effect on the respective economies differed, but in the end, each expects inflation to fall to their 2% target sometime in Q2 of this year.

However, the FOMC’s apparent coordination makes the path to agreement on rate cuts far more likely.

The President of the Minneapolis Fed, Neel Kashkari, will speak about the economy later today, and it will be interesting to note how much his comments differ from those of Goolsbee.

Yesterday’s publication of inflation data showed that headline price increases rose by more than the market had expected, to 3.4% from 3.1% in November.

Traders and investors are on high alert for any revelations about when the FOMC will consider its first cut.

Today PPI data will be published which will provide the FOMC with some indication about the future path of inflation as it shows how factory gate prices are reacting to the level of interest rates.

The coordination of FOMC members’ comments has led the market to believe that, irrespective of economic performance, the Fed will now be the first G7 Central Bank to cut rates.

For that reason, the dollar had a “down day” yesterday.

The index fell to a low of 102.15 and closed at 102.32. The fact that it is still in the range that began when the market returned from the Holiday shows that traders are not yet convinced about the path for the Greenback over the first quarter and beyond.

The Euro is benefitting from the inability of members of the ECB’s Governing Council to agree on the future path of short-term interest rates.

Some still feel that there is a threat that rates may not be cut at all this year, or in Q4 at the earliest, while there are others who would agree to a rate cut at the next meeting.

This unhealthy level of disagreement makes the market edgy about the long-term future of the single currency, even though it has just “celebrated” its twenty-fifth anniversary.

With massive disagreements about monetary policy and no agreement about a fiscal union, the European Commission will need to show a far larger amount of diplomatic influence for the European Union to thrive in the long term.

Boris Vujcic, the Governor of the Central Bank at the Eurozone’s newest member, Croatia, and a renowned hawk on monetary policy spoke yesterday of his view that the Governing Council will need to see Q1 wage data, which is likely not to be available until early May, before a decision on rates can be made.

He did however agree that the current path of inflation is encouraging, but he will need to be convinced along with Joachim Nagel in Germany, and Robert Holzmann in Austria, along with less vocal hawks, if rates are to be cut before June.

As well as the UK and the U.S., the European Union will vote on the makeup of the European Parliament in June this year. 370 million voters will go to the polls to elect 730 MEPs.

The economy is likely to play an important part in the voting, while in some member states, like Italy for instance, it will be fiscal policy, decided locally, which makes the most persuasive argument.

Christine Lagarde gave an interview yesterday in which she spoke of her view that a recession can be avoided but the focus of the ECB is still on inflation, although she concurred with Vujcic that considerable progress has been made in that area.

The Euro continues to receive help from the interest rate outlook in the Eurozone, but it is still struggling to conclusively break the 1.10 level.

Yesterday it rose to a high of 1.1003 but again ran into selling pressure and was forced to retreat and closed at 1.0973.

Have a great day!