16 December 2024: Labour’s Budget has bitten into GDP

Rachel Reeves pronounced herself “disappointed” with the monthly growth figures published on Friday. The economy contracted for the second month and is now on “recession watch.”

If the economy contracted for the entire fourth quarter, it would be a significant setback to the government’s plans, while two consecutive quarters of contraction would see the economy in recession. This is now a real possibility.

The Prime Minister and the Chancellor have pinned their hopes on being able to promote a significant rise in economic activity and output, which will see tax revenue increase sufficiently for their plans for the economy to be funded without any further rise in taxation.

Official figures for October showed a 0.1% GDP drop in GDP when economists had been predicting a marginal rise. The ONS said the hospitality sector and retail were among the sectors reporting “weak” figures. Manufacturing and construction declined, by 0.6% and 0.4%, respectively.

While pubs, restaurants, and other hospitality sector areas may reasonably expect to see a rise in activity in December, Construction traditionally “shuts down” over the Christmas period.

The CEO is one of Britain’s biggest builders, Barratt Woodrow, believes that the Government’s plans to build 1.5 million new homes throughout this Parliament are not workable due to the significant skills shortage that has happened since Brexit.

The Barratt Redrow chief executive, David Thomas, when asked by the BBC if there were enough workers to build the extra homes promised by Keir Starmer and Angela Rayner, said: “The short answer is no.”

He added that the government would have to “revolutionize the market, revolutionize planning, revolutionize methods of production” to make their target achievable.

“They’re challenging targets. I think we have to recognize that this is a national crisis,” Thomas said.

The Home Builders Federation (HBF) echoed Thomas’ sentiments.

The HBF told the BBC the UK “does not have a sufficient talent pipeline” of builders to meet Labour’s goal, citing recruitment constraints with poor perception and lack of training within schools, not enough apprenticeships, and the cost of taking on apprentices.

The industry body said the sector had not “attracted” enough recruits in recent years, saying a quarter of tradespeople were aged over 50.

The concerns from within the construction industry have dampened prospects for the Prime Minister’s construction targets, after he said on 5 December his government would “absolutely” push development through.

Starmer said he wanted to “get the balance right with nature and the environment” but that “a human being wanting to have a house” had to be the top priority.

The pound is expected to rally this week despite the slowdown in market activity as we enter the last full week of the year. A rate cut is expected in the U.S., while the Monetary Policy Committee is expected to leave rates unchanged when it meets on Thursday.

Last week, Sterling fell to a low of 1.2603 and closed at 1.2619.

The market has performed close to a 180-degree reversal of its earlier view and is now expecting the FOMC to cut rates by twenty-five basis points when it meets on Wednesday.

A cut is now widely expected to be agreed in the final meeting of the “Biden era”.

The Fed is also expected to signal a slower pace of future cuts amid uncertainty over the impact of President-elect Donald Trump’s economic proposals.

Biden leaves the White House on Jan. 20, handing the keys back to the Republican Trump for a second term, and analysts expect major policy changes.

The Fed is expected to be more gradual in its easing of monetary policy given the policies that will be put in place by the Trump administration. While the Fed is mandated to act independently of Congress when tackling inflation and unemployment, it still must consider the effects of the government’s fiscal policy on the world’s largest economy.

Trump has vowed to tackle the high cost of living, a top concern of voters who sent him back to the White House in November’s election. However, many analysts have voiced concern about some of his key policy initiatives, most notably his threats to implement sweeping tariffs on finished goods entering the U.S. and deport millions of undocumented workers.

Since September, the Fed has cut rates by 0.75 percentage points, pivoting from prioritizing its long-term inflation target of 2% to better supporting the labour market.

The data have driven the Fed’s shift in posture, its favoured inflation gauge has fallen sharply this year and is at a level that was considered unachievable, when paired with rate cuts, in January. And, despite a recent uptick, is still close to its 2% target.

Since the Fed’s role is to balance maximum employment and relative price stability, it leans heavily on the monthly Bureau of Labor Statistics jobs report and the Consumer Price Index report when deciding whether to raise or lower the federal funds rate.

Annual inflation is gradually improving, down to 2.7% from 9.1% in mid-2022. But price growth is still stubborn, and inflationary pressures are expected to increase with the next administration.

The labour market also plays a role. In September, with signals that the market was softening, the Fed started lowering rates to avert a recession. The November data showed that those rate cuts are having a positive effect. Today, unemployment is higher than last year’s low (4.2% versus 3.4%), but the job market isn’t collapsing.

The dollar index is not likely to be significantly affected by a rate cut this week. The economy is still robust and is performing significantly better than many of its G7 partners.

Last week, the index climbed to a high of 107.18 and closed at 106.98. As we approach the end of the year, traders will be considering how they can start 2025 with positive P&L numbers.

They are likely to conclude that a reduction in the number of rate cuts by the Fed, compared to policy easing in both Europe and the UK, should lead to a stronger dollar.

Finally, the ECB has signalled a change in its priorities from reducing inflation to promoting growth.

After the ECB opted to reduce its Deposit Facility rate by 25 basis points to 3%, Christine Lagarde highlighted the deteriorating Eurozone growth outlook amid a slowdown in exports and weak business investment, which points to the need for further policy easing.

“Surveys indicate that manufacturing is still contracting and growth in services output is slowing”, she said, while adding that firms are holding back their investment spending in the face of weak demand and a highly uncertain economic outlook.

The ECB’s relationship with the European Commission is difficult since on the one hand it is expected to react to decisions made that affect growth, output and inflation levels, while on the other they are expected to also create policy that limits inflation and promotes growth.

Lagarde’s comments appear to show that some of her colleagues on the Governing Council were in favour of a larger rate cut than was eventually agreed.

The latest ECB projections are for the economy to grow 0.7% this year and by 1.1% in 2025. This is lower than its previous forecast.

The European Central Bank should lower interest rates further but probably won’t need to take them to levels that would stimulate economic expansion, according to Governing Council member Martins Kazaks.

In an interview, the Latvian official argued that inflation isn’t on track to fall below 2% and that the ECB can afford to gradually trim borrowing costs to the point, known as neutral. Where they stop restricting growth.

“The direction for rates is down, we’re clear about that,” Kazaks said. He added, however, that he’d be “very, very cautious” about going below the neutral rate as the economy isn’t that weak (!) and the ECB’s current outlook doesn’t suggest inflation will fall short of the target for long in years ahead.

He is driven by the latest data and is not too concerned by the political situation in Germany and France which could lead their economies, and by association, that of the Eurozone into recession.

His comments echo those of his colleague, German Economist Isabel Schnabel who is also calling for caution in cutting rates too far or too fast.

The problems facing France and Germany are not being reflected yet in economic activity from the region’s “peripheral” economies.

Economic growth in the Netherlands will pick up in the coming years, growing 0.9% this year and 1.5% each in 2025 and 2026, despite an increasing threat from geopolitical uncertainty. Inflation will remain at around 3%, higher than in the rest of the eurozone, De Nederlandsche Bank (DNB) reported in its autumn forecast.

Meanwhile, Portugal’s economic growth is projected to exceed the Eurozone’s average by more than double this year and next, according to the latest economic report by the OECD.

The euro is still reactive to changes in monetary policy. Last week, it fell to a low of 1.0453 but rallied to close at 1.0497 as the prospect of a cut in rates in the U.S. to match the one agreed by the ECB is expected to happen on Wednesday.

Have a great day!