18 September 2024: August’s inflation data may encourage the Bank of England to remain cautious

The latest inflation data is due to be released this morning, and even though the market does not expect the Bank of England to cut interest rates at its latest meeting which concludes tomorrow, the figures are expected to confirm that prices rose by 3.5% in August, up from 3.2% in July.

The worst possible combination of rising inflation and falling growth will test the Government’s mettle in the run-up to the Autumn Budget, which will be presented to Parliament on the 30th of October.

If Rachel Reeves presents a severely austere budget in which public spending is cut and taxes rise, it may cause the economy to contract. In the current quarter, the economy has likely failed to grow.

Outgoing Conservative Party Leader, Rishi Sunak, has been criticised for the timing of the General Election, but the result would have been a little different if he had delayed. Since Inflation is rising again and the growth that was seen in the first two quarters has petered out, in any event, the public had decided that they would vote for anyone as long it wasn’t a Tory.

Figures published yesterday showed that Keir Starmer’s popularity is in free fall. Labour’s polling has plummeted to an average below 30%, something no new government has managed in over forty years.

In just seventy days, the honeymoon period has “hit the buffers”. The next fastest fall from grace was John Major’s in 1993 which took a little over a year before his support eroded to the points Labours is now.

Of course, the Government can lean on the fact that it has a more than healthy majority but will have to do more than simply blame the previous administration if its popularity is to recover.

Failure to do anything practical to stop the boats, the obvious control over policy that Trade Unions are exerting, the threat of tax increases and the disastrous withdrawal of pensioners’ winter allowance have led to a difficult start as Prime Minister for Starmer.

There is some good news for consumers. Although interest rates probably won’t be cut tomorrow, several of the major banks are cutting their mortgage rates, with Santander now offering a rate of below 2% for a two-year fixed loan.

The pound’s performance over the past week has been driven by the dollar, and whether the rate cut that will be announced later is twenty-five or fifty basis points.

Yesterday, it fell to a low of 1.3146 reversing most of the gains that were made on Monday. It eventually closed at 1.3163.

The market has been awaiting this day for the entire year, and in some cases even longer than that.

Today will see the Federal Reserve cut interest rates for the first time in more than four years. In both the first and second quarters, conditions did not lend themselves to a rate cut. Although leading indicators were beginning to point to lower activity and output, growth was still running at a reasonable level and inflation had stalled.

An expected cut in July didn’t materialize, despite several members of the FOMC voting for a loosening of monetary policy. That has led to an expectation that a fifty-point cut will happen today as the Fed plays catch up with the ECB.

However, the economies of the Eurozone and the U.S. are at a different stage in the cycle currently. While the Fed has never cut rates when the economy is exhibiting a healthy level of growth, the Eurozone is teetering close to contraction, with its largest economy, Germany, already in a technical recession.

Ever since the start of the year, there have been dire predictions about the economy, but even as recently as last month, retail sales picked up to grow at 0.3% while industrial production rose by 0.8% after a 0.6% fall in July.

It has been the level of job production that has mainly kept the Fed from cutting rates. Earlier in the year, it was expected that job growth would turn negative if the Fed persisted with a Fed Funds rate of more than 5%.

However, the lowest headline number for the entire year so far has been just below 100k.

This is another reason it is difficult to envisage a fifty-point cut today.

Jerome Powell has gained the grudging respect of Wall Street for his stoic refusal to stoke the fires of the equity markets, which even with rates at 5.25% are still close to record levels. Having seen a significant correction in the Summer, the Nasdaq closed yesterday at 19415, which is less than 1000 points from its all-time high.

The market’s attention will be on the size of the cut today, but it will also study Jerome Powell’s comments at his news conference for any advance guidance on the plan for the rest of the year.

The dollar index rallied to a high of 101.03 yesterday as the idea of a fifty-point cut lost traction. It eventually closed close to its high as the market positioned itself to begin to consider comparative growth rates as it pivots along with G7 Central Banks.

In a scene not dissimilar to the old Western films, it seems that Mario Draghi “rides again” to rescue not the Euro this time but the entire Eurozone economy. There has been little time, so far, for individual Eurozone members to study the eight-hundred-page document in detail, although both Ursula von der Leyen and Christine Lagarde have provided contrasting views.

Von der Leyen appears content to allow Draghi free rein to drag productivity and competitiveness into the twenty-first century, while Lagarde, concerned about German reaction, has given the plans a lukewarm welcome. “Structural reforms are not the responsibility of the Central Bank, they are the responsibility of governments”, was Lagarde’s response.

Lagarde was happy to endorse the plan but made it clear that reform would need to be paid for by individual Governments.

Published on Monday, the former ECB chief’s widely read report called for greater centralization of the European economy, with a clear industrial policy requiring some €800 billion a year of investment to spur growth.

Delivering his report to the European Parliament in Strasbourg, yesterday, Draghi commented that it may be the cheapest and most efficient way for the EU to meet its green commitments by relying on China, which at current levels of output will be able to comfortably satisfy global demand for solar cells and battery cells by 2030, but the region needs to begin to independently create its green industries and initiatives.

The report on Europe’s ailing economy contains some hard truths for its leaders, who have for too long avoided tough decisions. Draghi said his report recommended returning to normal state aid rules in the EU, allowing state subsidies only for investments in projects of common European interest.

Meanwhile, Lagarde rebuffed Italy’s call for the ECB to be bolder in making monetary policy decisions. Two Italian Ministers had criticized the ECB, saying it “lacked courage”. Lagarde retorted that the Central Bank is an independent institution, not subject to political pressure.

The euro lost ground yesterday as the market prepared today’s decision on interest rates from the Fed.

It fell to a low of 1.1111 and closed at 1.1113.

Have a great day!