Soaring inflation and higher taxes set to slow economy

The Government announced changes to its plans for rail infrastructure in the north of the country. HS2, the high-speed rail link between London and Birmingham, then on to the major cities of Manchester and Leeds, will now see track north of Birmingham upgraded rather than replaced.

This has been met with severe criticism, particularly in the north-east, where business leaders have slated the amended plan as an example of this Government’s levelling up process being little more than an eye-catching vote winner from the last election that is without real commitment.

Furthermore, the numbers that were announced yesterday for new investment include funding that has already been either agreed or already provided.

The plans have created divisions even between Members of Parliament from the same party, as it creates a significant disparity between the east and west of the country in areas north of Birmingham.

So, a policy that was originally labelled the powerhouse of the north has been watered down considerably.

When interviewed on the subject. The Prime Minister insisted that the project remains a keystone of Government policy, commenting that the reality is that the timing of improvements to transport infrastructure in the north have been brought forward by up to ten years.

It remains to be seen if the changes add to the draining away of support for a government that has been under pressure over several issues recently.

The cost of living is becoming another significant issue that illustrates a here and now attitude with little forward planning. While no one would doubt the fact that the Chancellor has had to be realistic in his need to rebalance fiscal policy, there is too heavy a burden about to be placed on middle income families who will see not only their mortgage payments increase but also suffer higher taxes.

With inflation now a major factor in the economy for the first time in a decade, interest rates may have to be increased at a pace that the Central bank was desperate to avoid. While the bank’s independence is now set in stone, Governor Andrew Bailey is still going to be asked by the Chancellor for the reasons why the MPC declined to raise rates at its most recent meeting.

The one beneficiary of the now almost certain rate hike at the December 16th meeting is the pound.

It has rallied strongly against the euro and held its own versus the dollar. While the market’s focus is on diverging monetary policy between London and Frankfurt, the early part of 2022 will more likely be dominated by comparisons between economic performance.

Versus the euro, the pound remains well above support at 1.1850, while versus the dollar it has recovered ground so far this week. Yesterday, it closed at 1.3490.

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Employment and consumer activity set to drive growth

The most recent employment report in the U.S. appears to have been a catalyst for improved confidence in the recovery of the economy from the ravages of the Coronavirus Pandemic.

Most recent data releases, while still affected by logistical issues, are showing that output is beginning to improve while consumers are gaining in confidence and beginning to spend the savings that had been built up during the lockdowns.

Even the beginning of the withdrawal of additional support by the Federal Reserve is being viewed positively. It has been interpreted as a show of confidence from the Central Bank that it is not only aware of rising inflation but willing to begin to tackle it.

There were a number of comments made by FOMC members yesterday, with more expected today.

John Williams, the President of the New York Federal Reserve, outlined a realistic view of rising inflation, commenting that he is seeing more broadly based rises in inflation that need to be addressed.

His colleague, Chicago Fed President Charles Evans, noted that the economy now has good momentum that will last well into 2022. He also noted improvements in the labour market, fuelling an expectation that the unemployment rate will fall to 4% and could even reach 3.5% depending on how long favourable conditions last.

Yesterday’s release of weekly jobless claims came in at a Pandemic low of 268k. Although expectation was for a fall to 260k, the trend is still going in the right direction.

Inflation is the great imponderable, having reached 6.2% last month. With energy prices still rising despite a fall in the oil price yesterday, it is expected that it will peak a little over 7%

The dollar index is still supported by the expectation of a continued gradual tightening of monetary policy. Yesterday, it closed at 95.57 as profit began to be taken on traders’ long positions.

If President Biden remains true to his comment earlier in the week, the outcome of the decision on whether Jerome Powell is to remain as Chairman of the Federal Reserve or be replaced by Lael Brainard will be announced today.

Inflation set to peak this month

The housing market in the Eurozone is a difficult area to gauge since it is driven by so many features that are conditions in each of the nineteen member states. For that reason, housing data has never been considered with a representative or reliable indicator.

However, ECB President Christine Lagarde has begun to consider house prices as an indicator, particularly in the wealthier northern states.

House prices in Germany, The Netherlands and Austria are heavily subject to any change in monetary policy and given the rise that has been seen since rates were slashed in the wake of the Pandemic, even a hint of a rise could see prices crash in those countries.

French President Emmanuel Macron received a blow to his re-election campaign yesterday as an OECD review of the economy recommended that in the public sector working hours should be increased, and its pay should be cut.

Furthermore, it recommended a rise in the pension age.

All these measures are considered important to make France competitive again.

However, the notoriously militant public sector is, at the very least, unlikely to react well to such suggestions.

Any lowering of state benefits has been historically met with street protests that frequently turn ugly. The President, already under pressure to ensure that French fishermen don’t lose out to their British counterparts following Brexit, will find it impossible to implement any changes if he holds out any prospect of being re-elected next Spring.

Robert Holzmann, the Governor of the Austrian Central Bank, spoke yesterday of his fear that inflation is likely to remain high and called upon the ECB to immediately begin to remove the support provided by asset purchases.

He believes that not only does the Central Bank needs to act to slow the rise in inflation which he sees as inevitable as the region escapes from the pandemic, but the fact that it is also artificially lowering borrowing costs for weaker economies to be a worrying development.

The euro has recovered a little, having made a new low for the year this week. It reached a high of 1.1371, closing, close to that level.