22 August 2024: The black hole is still growing

Government borrowing, the gap between income from taxation and spending, rose to its highest level since 2021 last month. Public sector net borrowing rose to £3.10 billion, nearly double the expected level.

The Office for National Statistics highlighted rising social benefits, pushed higher by inflation and rising government wages, as drivers of increased spending compared with a year ago. The figures did not include recent pay deals between the new Labour government, elected last month in a landslide victory, and public sector workers, including junior doctors.

Rachel Reeve’s deputy, Darren Jones, said the figures prove the dire state of the country’s finances.

One economist was quoted as saying that he expects the Government to borrow twenty billion pounds more each year over the life of this Parliament and fund medium-term spending with higher taxes.

Many City commentators have raised their expectations for growth this year. Jeremy Hunt, Reeves’s predecessor as Chancellor, was scathing in his comments about her plans to announce tax increases in October.

He said that on the one hand, she announced that the country was suddenly in a massive black hole, then she was able to “magic up” inflation-busting pay deals for Labour’s union “paymasters”.

Over the past two weeks, the economy has received two important sets of data which may be able to see the country escape the worst of the expected tax increases.

Although inflation rose marginally last month, it is still falling overall and is unlikely to see any significant increase before the end of the year, even if energy prices rise again.

Then, the economy showed a level of resilience that was not expected which should be rejoiced by the Chancellor, instead, she has talked down the undoubted progress as she prepares to raise both inheritance and capital gains taxes.

The pound is reacting to the market’s view that the Federal Reserve will cut interest rates at its next meeting. Yesterday, it continued to rally, reaching a high of 1.3119 and closing at 1.3091.

Versus the euro, it has begun to claw back some of its losses over the past month. Yesterday it closed at 1.1739.

A data release that does not usually concern the market was pounced upon by market analysts yesterday as a further reason the Federal Reserve will cut interest rates next month.

The number of jobs created in the year to March was 818k less than previously indicated by the month-by-month numbers, even though that was less than the one million loss the market had expected.

The revised total adds to evidence that the job market has been steadily slowing and likely reinforces the Federal Reserve’s plan to start cutting interest rates soon.

Job growth averaged 174,000 a month in the 12 months that ended in March, a drop of 68,000 a month from the 242,000 that were initially reported.

This is evidence that the jobs market is slowing, albeit moderately, if a fall of more than 25% can be considered moderate and reinforces the probability of a rate cut as the economy archives the fabled soft landing that has been considered for most of this year.

In Jerome Powell’s keynote speech tomorrow at the opening of the Fed’s Jackson Hole Symposium, the market will be “hanging on every word” he says, although he is not expected to be subtle in his comments.

The minutes of the last FOMC meeting were published yesterday. The meeting was held three weeks ago, before the release of the July employment report, which sent the dollar into something of a tailspin.

From the minutes, it was clear that several members of the Committee wanted to cut interest rates there and then and are not only unlikely to have changed their view in the past three weeks but are likely to have been joined by many of their colleagues.

Financial markets have been expecting the September meeting to kick off the Fed’s policy easing, with as much as a full percentage point worth of rate cuts expected by the end of this year.

At the July meeting, most policymakers thought that “if the data continued to come in about as expected, it would likely be appropriate to ease policy at the next meeting,” the minutes said.

This is by far the clearest signal yet from a G7 Central Bank that it will cut rates in September. Doubts remain about the actions of the Bank of England and the ECB, although on balance they may be cut as well.

Since a cut by the FOMC will simply “level up” monetary policy given that both the ECB and BoE have cut once already, it is the future path of interest rates that is driving the market.

The Fed will be more proactive than either of its main G7 partners, as both will likely be driven by the data, particularly inflation, which is set to rise in Q4.

The dollar has fallen at every session since last Thursday. This must now be considered a “change in trend”, rather than a “correction”, although as more traders “join the herd”, the “smart money” may begin to “bargain hunt”.

The dollar index fell to a low of 100.92 yesterday but recovered a little to close at 101.18.

The lack of news emanating from the ECB and/or its Governing Council members has led the market to believe that there has been no change in its view of the economy and the path of inflation since it last met back in July before they all left on holiday.

There has been an assumption that because the pace of deflation has slowed in the intervening period, a cut in interest rates may not happen at the September meeting.

Olli Rehn, The Governor of the Finnish Central Bank, was the first Governing Council member to comment for a couple of weeks yesterday.

He spoke of the need for the ECB to cut rates next month in light of “continued economic weakness”. Not only was this the first dovish comment for some time, but it was also a departure from the ECB’s main theme.

It has studiously avoided concerns about a recession, concentrating almost exclusively on inflation.

Rehn argued that the long-expected pick-up in the Eurozone’s economy was not a given, and policymakers should be prepared for different outcomes.

The unwelcome news relates to the growth outlook: there are no obvious signs of a pick-up in the manufacturing sector,” Rehn said. “We must also consider that the slowdown in industrial production may not be as temporary as assumed.”

Rehn was more relaxed about inflation but warned that the ECB’s 2% target would be difficult to achieve.

His comments should have injected a sense of realism into the market, which has been almost exclusively concentrating on the prospects for the U.S. economy over the past month.

This has led to the Euro becoming significantly overbought currently, and it may well be considered ripe for a correction.

The ECB is a powerhouse in the EU, wielding influence over financial supervision, foreign exchange reserves, and economic forecasts.

With current economic stagnation and geopolitical tensions, the ECB’s decisions are sparking heated debates across the region. However, the economies showing the best performance are still calling for rate cuts, while those who are struggling are satisfied with the status quo.

The Euro continued its recent rally yesterday, climbing to a high of 1.1174, its highest level for thirteen months. It then corrected slightly to close at 1.1147.

Have a great day!