23 January 2025: Spending cuts risk a doom loop – Haldane

Former Bank of England Chief Economist, Andrew Haldane, believes that the Chancellor has backed herself into a corner from which the only escape is to cut public spending.

The continuing furore that began with her October budget in which she raised taxes, clinging to a semantic excuse that she never said the company’s tax burden would not increase means that a repeat is opiate of the question in March.

UK borrowing hit its highest level in four years in December, so either increasing or breaking her self-imposed debt ceiling is out of the question. That leaves spending cuts which will also be deeply unpopular with traditional Labour voters.

Haldane believes cutting government spending would harm the UK’s longer-term fiscal position because it would weigh on growth.

The Chancellor will receive fresh economic forecasts from the OBR in March, which will consider the sluggish growth since the Budget and higher government borrowing costs.

These forecasts could force Rachel Reeves to cut spending to meet her key fiscal rule, which ensures that tax receipts meet day-to-day spending.

“It would be deeply counterproductive to both growth and to the fiscal position if that led to a cutting back on investment and indeed in spending more generally,” he said.

“Then you are in a doom loop between debt and growth. And that is a situation to avoid at all costs.”

The government has promised to deliver “ruthless” spending cuts in the spending review, which will determine the scope of departmental budgets for the rest of the decade.

Reeves is in Davos for the World Economic Forum, Europe’s equivalent of the Federal Reserve’s Jackson Hole Symposium.

She appears to have struck up a friendship with the head of the World’s Largest Sovereign Wealth Fund. Norway has a fund which is conservatively estimated to hold the equivalent of one trillion pounds in investments, many of which are already placed in the UK.

The fund’s CEO is “very impressed” with the vision for the UK outlined by both Reeves and the Prime Minister. Just yesterday, he approved a purchase of more than three hundred million pounds for the Duke of Westminster’s investment in Mayfair property.

In the clearest statement yet of the Government’s new priorities, the Chancellor said projects which could boost growth should not be held back because they might add something to carbon emissions in 20 years.

Asked whether she would choose to prioritize the economy or tackling climate change, she said growth was her ‘number one mission,’ adding: ‘It’s the most important thing.’

The pound fell back as the volatility brought about by President Trump’s inauguration faded. As reality returned, the pound fell to a low of 1.2307 and closed at 1.2317.

The mood around the financial markets has brightened, with investors willing to invest in risky assets moving away from the dollar’s safe-haven status.

The IMF CEO spoke in an interview in Davos of her belief that the U.S. will lead the world in growth in 2025. Kristalina Georgieva also warned that Donald Trump’s threat to impose sanctions on its largest trading partners, particularly China, could see the most aggressive trade war that the world has ever seen.

There are a handful of warning signs regarding the health of the U.S. consumer right now. Interest rates are still high, and there’s a good chance they’ll stay that way for the foreseeable future.

Meanwhile, according to data from the New York Federal Reserve, delinquencies on credit cards and auto loans have been rising for over a year now. This is believed to be one of the most reliable early warnings of trouble brewing “down the line.”

People are still using the aid they received during and just after the pandemic to settle bills, according to a survey conducted by RBC Capital Markets recently.

Strong jobs data will continue for at least the rest of this quarter and maybe for the entire first half of the year, but if job creation begins to falter, the Fed will need to act swiftly and pre-emptively to head off any issues.

Jerome Powell is well known for being cautious about rate cuts. He just about got away with leaving the first cut in rates until September.

The Fed has promised to pursue its own green agenda, tempered by its own needs and necessities, in comments that echoed the sentiments of the President.

The official reason for the Fed’s withdrawal from the group tasked with the “greening” of the global financial system is that there are concerns that its membership contravenes its mandate.

However, the move by the Fed and FDIC is more in line with the latest views in Washington on how climate change is viewed and dealt with.

President Trump’s “drill baby drill” comments during his inauguration say all that needs to be said about the new Administration’s view on greenhouse gas emissions.

The dollar index has resumed its rally at a more even pace as Trump’s rhetoric has been replaced by a more considered approach to the global economy. There are still concerns about the effect of tariffs on the U.S. economy; the prospect of a loosening of monetary policy is offsetting the IMF’s growth expectations.

Yesterday the index rose to a high of 108.27 and closed at 108.25 as traders saw an opportunity as day traders closed short positions.

There is 100% certainty in the financial markets that the ECB will cut rates at its meeting next week. The only remaining issue is whether the traditional doves can persuade those of a more hawkish persuasion that a fifty-point hike should be considered.

Market commentators believe that the ECB will cut by twenty-five points at every meeting from next week to July but given the political turmoil in Germany and France and the economic chaos that is apparent in both the Union’s two largest economies, a jumbo rate cut must be on the cards.

The level and scale of the proposed interest rate cuts need to be seriously considered at next week’s meeting. Isabel Schnabel, an ECB Board Member and part of the rate-setting Governing Council believes that the Central Bank has got itself into a position it was trying to avoid.

There is no jeopardy in the market positioning itself for a rate cut next week, as several Governing Council Members have already confirmed it will happen.

Schnabel wants every meeting to be stand-alone in its consideration of monetary policy, considering both the global and local economies.

Germany’s economic weakness and stagnation will persist into the first months of the year, the country’s central bank, the Bundesbank, stated in its monthly report for January.

“It is also unlikely that the German economy will manage to escape the prolonged period of stagnation in the first quarter of 2025,” the Bundesbank said in the report, which was released yesterday.

“The German economy remained listless in the fourth quarter of 2024,” the report stated.

Industrial output appeared to continue declining in the fourth quarter, as orders from abroad remained subdued, according to the Bundesbank.

Overall trends in demand for German industrial goods, however, appeared to stabilize somewhat at the end of the year, the central bank said.

Germany’s construction industry remained mired in problems and is unlikely to boost growth.

Private consumption, on the other hand, should have recovered, but “households held back on spending despite sharply rising wages,” the Bundesbank noted. “As a result, their saving rate rose while private consumption increased only slightly.”

The European Commission in Brussels is not providing any guidance regarding Mario Draghi’s long-awaited report, which could serve as a roadmap for a recovery of the entire region.

His proposals, although not necessarily new, are detailed, courageous, and ambitious and point out that the only feasible way forward for the European Union is through greater integration, according to analysts and economists.

Meanwhile, despite its show of relative strength so far this week, the market appears resigned to the euro eventually reaching parity with the dollar as monetary policy diverges further.

Yesterday, the single currency rallied to a high of 1.0457 but ran into sell orders which pushed it down below 1.04 before it recovered to close at 1.0412.

Have a great day!