13 February 2024: Wages as well as food prices are a major obstacle to lower rates – Bailey

Brexit is still a significant drag on UK productivity, despite the Government’s continued efforts to convince people that the implementation of the deal to leave the European Union is in the country’s best interests.

Economists at global investment bank, Goldman Sachs believe Brexit has shrunk the economy by around 5% reducing growth and adding to inflation.

The reticence of investors to commit to the country due to the uncertainty that continues to surround the country’s ability to agree on trade deals with important trading partners like the U.S., Canada, and India is holding back its development of new export markets.

The UK imports a substantial volume of its agricultural product needs, and there have already been small but significant protests from farmers who believe that imports of cheap, low-quality meat, fruit, and vegetables are destroying their livelihoods.

It may well be that the changes to the economy that Brexit have brought could mean that the Bank of England’s 2% for inflation is now undeliverable.

The Brexit deal was negotiated while the country was still recovering from the Pandemic, so it was hard to differentiate between the economic effects of the two considerable drawbacks to economic growth.

As the effect of the Pandemic fades, it has left Brexit as the single most important barrier to lowering inflation.

It may very well be that the 2% target is too politically sensitive to be adjusted, since the two major political parties will see any change, no matter how necessary, as providing ammunition to the other for their inability to control the economy.

Today will see the publication of the January employment report. Average earnings are predicted to fall to 6%, down from 6.6% in December. While pay awards are still above the rate of inflation, the Bank of England will have difficulty justifying a cut in interest rates.

Later this week, the Q4 GDP figures will be released. The data may “drive another nail into the Government’s coffin” as it is eminently possible that the economy has entered a recession, although it may be mild and short-lived.

Following a 0.1% contraction in Q3 and negative growth reported for Q4 will mean that the country is in recession, even if it is in “name only”.

Sterling had another quiet day as the market awaits important data released from both sides of the Atlantic.

The pound closed at 1.2628 unchanged from its close on Friday.

In a survey published yesterday, 21% of members of the National Association of Business Economics believe that current monetary policy is too restrictive.

Economists have found a new risk to the economy as inflation falls towards the Fed’s target, while the latest employment data indicates a soft landing for the economy.

There is a “push and pull” between fiscal and monetary policy. While fiscal policy remains expansive, with the Biden administration providing several initiatives that drive the economy forward, monetary policy remains restrictive. Discussions between Janet Yellen and Jerome Powell about policy coordination appear to be almost non-existent.

A leading hedge fund manager confirmed in an interview yesterday that the most likely scenario for the U.S. economy is for it to achieve a soft landing, but unless the Fed follows this with a series of interest rate cuts, it is likely to be quickly followed by a significant slowdown, although a full-blown recession is unlikely.

Torsten Slek, the Chief Economist at Apollo Asset Management, believes that there will be “a precarious balance” struck as the Fed cuts rates, but they take time to work their way into the economy.

Mergers and Acquisitions activity has started the year in a buoyant state, following last year’s almost moribund market. This has led to a strong employment market, which will likely continue throughout the first half of 2024.

Several clouds are gathering on the horizon which will make the second half of the year unpredictable. The Presidential Election and what the Fed will do if inflation stalls or begins to rise again, even if the cause is geopolitical, are two of the most significant risks.

Michelle Bowman is a member of the Fed’s Board of Governors and is a hawk when it comes to monetary policy. She made a rare speech yesterday in which she ruled out any immediate easing of monetary policy, commenting that it is too soon to say when, and by how much, the FOMC will cut interest rates this year.

She believes that “many risks” remain for any confidence to be felt that inflation is under control.

The dollar index has remained in a very narrow range for almost a week. Yesterday it closed at 104.14 just three points higher on the day.

The German Finance Minister was asked an almost unbelievable question at a press conference yesterday. He was asked if Germany could consider leaving the European Union if it was felt that membership was hampering the country’s economy.

Christian Lindner’s response was as expected that the Single European Market is of the utmost importance to Germany. While the answer was predictable, the fact that the question was even asked means that doubts about Germany’s membership of the EU are no longer confined to the rhetoric of the far right.

Lindner went on to say that if Germany were to follow the UK in leaving the Union, it would ruin its economy. The Alternative for Germany Party is on record as saying that the UK was “dead right” to leave the Union and that Germany should hold its vote.

The leader of the AfD, Alice Weidel, said recently that the EU needs radical reform and if that is not possible then a withdrawal should be put to the German people.

The chances of that happening are slim to non-existent, but even the fact that the conversation is being had may be a cause for concern.

Several members of the ECB’s Governing Council have spoken about monetary policy in the past week. It is clear who the doves and hawks are, and it appears that the balance is held by the moderates now with the Governors of the Central Banks of France, Belgium and The Netherlands to the fore.

Christine Lagarde appears to have suffered a near-fatal blow to her credibility following the publication of a poll of ECB staff that severely criticized her management style.

The market is still at odds with the ECB over the timing of the first cut in rates. While a cut at next month’s meeting is considered unlikely, some market practitioners refuse to rule it out completely.

The comments made at the weekend by Italian Central Bank Governor Fabio Panetta, led to bond yields falling moderately yesterday as it was the first time he had made a fervent speech confirming that rates would fall this year, and made a welcome contrast to Robert Holzmann’s comment that a cut in rates is still “in the balance”.

The euro lost a little ground yesterday following Panetta’s comments but still has a degree of support from the rate outlook. It fell to a low of 1.0754 and closed at 1.0777.

Have a great day!