22 April 2024: Truss kept Bailey in the dark

Members of the Government are beginning to question the definition of a recession to convince the public that the current upturn in economic activity started during the second half of last year.

Unfortunately, if it looks like a duck, swims like a duck, and quacks like a duck, it is probably a duck.

The data published during the period between July and December last year clearly shows that the economy teetered on the verge of contraction and, as the Head of the Office for Budget Responsibility said recently, it was always a risk that output would shrink, even if the shrinkage were minimal, as we have seen with hindsight.

While preparing for the upcoming General Election, the Prime Minister is trying to show that the path he set out, halfway through 2023, was correct.

He is likely wasting his time since the public knows full well that its pay bought less than it did one year previously, while household costs, like energy and services, were still rising.

Rishi Sunak is “swimming against the tide” gallantly trying to save a lost cause, and in all probability his job.

His political career will resemble the flight of Icarus in that he flew too close to the sun, and he will probably be replaced by Kemi Badenoch or Penny Mordaunt, depending on how radical Party members become in the face of what will almost certainly be a defeat of historic proportions.

The next meeting of the Monetary Policy Committee is scheduled for May 9th. While there remains an outside chance that the cut in interest rates will be made then, for no other reason than the longer the Bank of England waits to cut rates, the more likely it is that Andrew Bailey will back himself into a corner where political expediency or economic developments leave him with no choice.

One of Bailey’s colleagues as a permanent member of the MPC, David Ramsden, spoke last week of his view that the UK is no longer to be considered an outlier as far as its economic performance is concerned, preferring to use the far more tasteful sobriquet, “laggard”.

His thinking was already out of date since although the performance of the U.S. economy is “streets ahead” of the UK, the Eurozone’s most significant members have already been overtaken.

With the ONS predicting that consumer price inflation will continue to fall over the next few months, even if it may rise towards the end of the year, conditions will become favourable for a rate cut by June.

Sterling lost ground in the early part of last week as the dollar benefitted from the Fed’s more hawkish outlook on monetary policy, as well as haven flows from increasing tensions in the Middle East.

As the actions and reactions of Israel and Iran became less strident, the market breathed a collective sigh of relief and volatility fell.

The pound fell to a low of 1.2367 but recovered a little to close at 1.2372.

The interpretation of Jerome Powell’s recent comments has changed recently, as market participants finally see that the Chairman of the Federal Reserve has been more hawkish than his colleagues ever since the decision was made to pause and then end the programme of rate hikes.

In truth, Powell may well have argued for rates to rise for one, or even two meetings after the decision was taken, but the FOMC prides itself on its public pronouncements about monetary policy being unanimous so we will never know.

Several members of the FOMC have spoken recently of their view that either the FOMC needs to be in no hurry to cut rates given the performance of the economy, or their concerns, shared by Powell, that inflation is not falling quickly enough to allow rates to be cut before the Autumn.

Despite this, the “dot plot”, which is the amalgamation of FOMC members’ view of the number of rate cuts that will be possible this year, remains at three.

If that changes at the next meeting, which is scheduled to take place on May 1st, the market will finally be convinced that rates won’t be cut until September, at the earliest.

In fact, given the propensity of the FOMC to change monetary policy in consecutive “steps”, were three cuts to remain possible, they may well not start until October.

Were that scenario to become reality, the dollar would have a summer in which it remains strongly supported.

This week will see the preliminary data published for economic activity for March. The rise in both manufacturing and services activity is expected to remain well into expansive territory, adding to the view that the expected rate cuts will remain on hold.

The real estate market is considered an early indicator of any change in economic activity, and for that reason, numbers for new and existing home sales are being more carefully scrutinized than they have been over the past two or three years.

Not enough new homes are being built currently to satisfy demand. This reflects caution amongst housebuilders that the economy may not be able to sustain the current level of interest rates.

The housing shortage is having a ripple effect throughout the economy, which will eventually affect jobs, economic activity, wealth creation and inflation. Some of those factors are already in play, and they will be being monitored by the Fed. This has led to some regional Feds having a more hawkish view of interest rates than others.

The dollar index is underpinned by the impending changes that are expected to take place in G7 monetary policy, while the geopolitical situation is what drives the market on a day-to-day basis.

Last week, the dollar index rallied to a high of 106.51 but as tensions between Israel and Iran cooled a little it lost ground and closed at 106.11.

Having appeared to be reasonably committed to a cut in interest rates taking place at its June meeting, members of the ECB’s Governing Council, including its President, now appear to be looking for reasons why that cut may not take place.

Christine Lagarde made two speeches last week in which she cited the current tensions in the Middle East as a reason why the ECB may have to delay.

Economically, there is still a view that the data for first-quarter wage growth will be higher than expected, and this may also see the expected rate cut deferred.

This may only be a about of “cold feet” as the ECB has been successful in bringing inflation back close to its 2% target.

Although the IMF predicts that inflation throughout the G7 will rise marginally in the fourth quarter of this year, several members of the Governing Council, headed by Austrian Central Bank Governor, Robert Holzmann are worried that a series of rate cuts in an environment where inflation is beginning to rise again may inflame the situation.

Interest rates are such a “blunt instrument” with which to control monetary policy, particularly in an environment where fiscal policy is not only of no help but may also be a hindrance.

For this reason, the ECB is still being cautious, possibly overly so, in agreeing to the first cut.

This week will see data for economic output published across the entire G7. The data is treated more seriously across the Eurozone, given the substantial number of “moving parts” that make up the numbers.

Although manufacturing output is still well below the level of 50 which denotes expansion, services output has been expanding since the start of the year, dragging the composite index into expansion overall.

PMIs are less significant in their own right, but go together with other data, like investment and business confidence, to “paint a picture” of the overall health of the economy.

The single currency has been in a downward trend since it became clear that the ECB would embark on rate cuts some considerable time before the Fed.

Last week, it gained marginally as the dollar’s rise ran out of steam. It reached 1.0690 before falling back to close just a few pips higher at 1.0655.

Have a great day!