19 April 2022: Sunak facing resignation calls

Inflation not Partygate cause for departure for chancellor

The Chancellor of the Exchequer, Rishi Sunak, is facing mounting pressure to leave his post following a perfect storm of criticism of both his personal and professional behaviour.

Sunak was virtually unknown outside the Parliamentary Conservative Group when he was appointed to his role, his first ministerial post.

He quickly got to grips with providing support to those suffering from the lockdowns put in place to curb the advance of the Coronavirus Pandemic. He received several accolades about the measures he initiated and was credited with almost single-handedly saving the economy.

Now, as the country emerges from the pandemic, Sunak faces three major challenges, any of which could derail his meteoric rise to become favourite to replace the Prime Minister should he face no alternative but to leave his post.

A few weeks ago, rumours began to circulate regarding the tax status of his wife.

Akshata Murthy is the daughter of the Indian billionaire founder of the multinational IT company Infosys. She has been accused of using non-domicile status to avoid paying tax in the UK. on her overseas income. While there has been no accusation of anything illegal, the wife of the man who decides on taxation for the country avoiding paying tax is not a good look.

Sunak himself has come out strongly in defence of his wife, but his squeaky-clean reputation has taken something of a hit.

The Chancellor has also been fined, along with several colleagues, including the Prime Minister, over the Partygate scandal. He has chosen to make no public comment regarding this matter, but he is now tarred with the same brush as Boris Johnson and would be unlikely to survive should Johnson be forced from office. Furthermore, his status as Johnson’s natural successor has been severely tarnished, possibly irredeemably so.

Perhaps the most significant accusation being levelled at Sunak and the one that could ultimately damage him the worst is growing criticism, not necessarily of his performance as Chancellor, but of the insensitivity of his actions in the recent budget in which he was determined to begin to recoup the generosity he had shown to those affected by furlough.

An increase in taxation, including a rise in national Insurance contributions, has been labelled as unnecessarily hasty given the pressures that households are facing following interest rate increases, the raising of the fuel cap and inflation that is at its highest level in a generation.

There is no doubt about Sunak’s ability, but his judgement is now being questioned in several quarters, and he is not the darling of the Party he once was. This means that should Johnson leave his post, the country could again see another long and fractious fight, with several candidates vying for the top job.

Last week, the pound managed to cling on to support around the 1.30 level and as the dollar index failed to rally above the 100 level it managed to regain a little composure. It reached a high of 1.3147, but fell back to close at 1.3060. In holiday quietened trade yesterday, the pound retreated again and closed at 1.3006.

This week will again be quiet for data, with retail sales due for publication on Friday the most significant release.

As we approach another MPC meeting, member comments will start to play a part in market speculation regarding further tightening of monetary policy.

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Dollar to remain volatile until FOMC

The next FOMC meeting, which ends on May 4th is expected to lay out the Fed’s commitment to tightening monetary policy.

Fed Chairman Jerome Powell has already confirmed the Central bank’s commitment to bringing inflation under control, but it is likely that this will not be an issue that can be easily resolved.

The Fed’s target for inflation is 2%, but over and above that, it is charged with adopting policies that do not contribute to extreme volatility.

It is easy to see that it has failed to avoid volatility, but in its defence, the past two or three years have been exceptional, and the current global tensions caused by the conflict in Ukraine have added to concerns about the future environment.

As the Fed has changed its focus from supporting the economy to fighting inflation, there have been concerns raised in Wall Street and beyond regarding the possibility that an overaggressive tightening of monetary policy could lead the country into recession.

So far, while there has been some slowing of economic activity, that is only to be expected in the current global environment. What the Fed mustn’t do is appear complacent about any further drop in GDP, given the way it ignored rising inflation last summer and tried to pass it off as transitory.

Well known Wall Street Investment Bank Goldman Sachs currently rates the chances of a recession in the U.S. at around 35%, but a lot depends on the pace at which the Fed decides to reduce the size of its balance sheet.

Lael Brainard, the Vice chairperson of the Central Bank, commented last week that the amount by which the balance sheet will be reduced is expected to have the equivalent effect of two or three further interest rate hikes.

The market can accept that as long as it doesn’t take place all in this quarter, as that would be equal to slamming on the brakes too fiercely.

It is hard to imagine the Fed acting so aggressively that the economy contracts in two consecutive quarters since while the economy needs to be brought back to a neutral position following years of accommodative policy, it is still able to regulate its activities to achieve a relatively soft landing.

Last week, the dollar index found itself unable to cling on to gains above the 100 level, but managed to return to strength yesterday.

It rose to a high of 101.02 and closed at 100.86. While this is a new high for the year, it remains to be seen how the effect of the holiday shortened trading day will be dissipated.

There are no tier one data releases, although Jerome Powell will be making a speech later in the week. It is likely that he will go some way to setting out the Fed’s agenda for tighter monetary policy.

Lagarde changes her tune on stagflation

The result of last week’s ECB meeting has been a little hidden by the Easter holiday. This may be no bad thing, since, yet again, the Central Bank sat on its hands.

The ECB President spoke of her fears of stagflation, which may already be prevalent in parts of the Union.

Christine Lagarde said that she expects average inflation to be 6% for 2022. This already appears to be wishful thinking, since in March, prices rose by a year-on-year 7.5% on average across the entire Eurozone.

It will be hard for several nations to accept that with inflation currently running at very close to four times the target, that a fall to only three times can be all that is achievable.

The war in Ukraine is a major concern for the economy, with Germany commenting last week that it will be virtually impossible to wean itself off imports of Russian energy, in particular gas.

The ECB needs to act, it is no longer acceptable to be continually monitoring the situation, the time has come for action. Lagarde will need to decide on which is the lesser of two evils and which will have the greater lasting effect.

Both inflation and contraction of the economy are here to stay, but it is inflation that will have the longer lasting effect. As savings and pension pots are denuded, it will take longer for those to be replenished, even if inflation returns to its 2% target quickly.

It is to be hoped that a resolution can be found in Ukraine, although that currently looks unlikely and the threat of an escalation remains. There are expected to be several other shortages besides energy should the conflict extend into the next two quarters, and that will undoubtedly pull the economy into a deeper recession.

Next week, the outlook for the very existence of the Eurozone may look even more complicated as France elects a new President. It may very well be that Emmanuel Macron will remain in power, but the threat from right-wing candidate is real and growing.

While le Pen has, for now, reduced her Frexit rhetoric, she is still suggesting policies that will bring France into direct conflict with Brussels.

The election will have a straightforward effect on the single currency. Should Macron win, the pace of the current fall could be slowed, while a Le Pen victory would be considered a disaster in financial markets.

Yesterday, the euro continued its recent weakness. It fell to a low of 1.0770 and closed at 1.0783.

While a Macron win will provide a little support, that may prove only temporary as the market appears determined to continue a low but inexorable fall towards parity.