24 May 2023: The IMF remains cool on tax cuts

The IMF published a report yesterday in which it completely reversed its opinion of the UK economy this year. The international lender doesn’t now believe that the country will face a recession as it sharply upgraded its growth forecast.

It now expects the economy to grow by 0.4% this year, as opposed to a 0.3% contraction that it had predicted earlier.

It based its opinion on what it called resilient demand and the fall in energy prices.

Inflation is likely to remain “stubbornly high” with interest rates needing to remain relatively high to combat rising prices.

Managing Director, Kristalina Georgieva, praised the actions of Rishi Sunak and Jeremy Hunt for having taken decisive and responsible steps.

The markets have accepted Brexit as a fact of life and the fallout from the UK’s departure from the European Union has not been as severe as some had considered, although, in the matter of free trade agreements, there is still work to be done.

There remain considerable risks to the economy, the biggest of which come from a possible wage/price spiral.

Ms Georgieva cautions against tax cuts which she believes are neither affordable nor desirable. The report also agreed with the recent comments by Andrew Bailey in which he said that he doesn’t see inflation falling to the Government’s target of 2% before mid-2025.

The Bank of England Governor had earlier testified to the House of Commons Treasury Select Committee. He told the MPs that he believed that the economy had “turned a corner” in the past couple of months. He does, however, remain concerned about inflation which he said was higher than the Central Bank had expected due to the cost of basic foodstuffs and clothing.

Bailey was quizzed about interest rate policy. He told MPs that he can’t yet say what the peak will be, but the base rate is closer to the top than it was.

The April inflation report will be published later today. It will show a significant fall from the rate of 10.15 recorded in March. Headline inflation is expected to have fallen substantially to 8.2% while the core remains unchanged at 6.2%.

The pound fell to a low of 1.2372 as it briefly tested a line of support at 1.2394, but it rebounded to close at 1.2411.

The U.S. is taking baby steps towards an agreement to raise the debt ceiling.

President Biden has held meetings with the Speaker of the House, Kevin McCarthy, and while both called the talks “productive, finding a degree of common ground, no settlement has yet been reached.

With just days to go before the Federal Government effectively runs out of cash, creating a potentially catastrophic first-ever default, the actions of Congress have been labelled “foolish brinkmanship” by observers as hard-line members of both parties dig their heels in.

McCarthy criticized the President for waiting until the last minute to hold talks, although he remains optimistic that a deal will be done.

Biden hopes to tie in cuts in public spending to new tax hikes, a compromise that Republicans see as a non-starter.

While a recession is still considered a remote possibility, a default by the Federal Government would almost certainly tip the economy into a dangerous contraction and cost a significant number of jobs. It could even see the FOMC be faced with having to reverse its current monetary policy stance and cut short-term interest rates.

Assuming an agreement is reached, which is not considered certain but highly likely, the markets will start to consider what actions the FOMC will take at its next meeting.

Wael Kashkari, the President of the Federal Reserve of Minneapolis, commented yesterday that he is open to a pause at the next meeting, although he wants to see all the data that is available before making up his mind.

He is against a declaration being issued that the Fed is “done”, but would go along with a pause in which all options remain open while further data is produced and considered.

He believes that the lag in the effectiveness of Fed actions skews the result of the latest hike as the Central Bank comes close to the end of the cycle.

The dollar index is close to testing the top of its recent range. It reached a high of 103.64 and closed at 103.53 yesterday. Some medium-term resistance is cited at 103.60 and should there be good news released on the debt ceiling, or the market has another bout of risk aversion that could easily be broken.

Christine Lagarde repeated her oft-used line about there being more ground to cover to defeat inflation when she was asked yesterday about when the ECB will be in a position to pause its cycle of rate hikes.

Since adjusting her position to fall more in line with the more hawkish members of the Governing Council, Ms Lagarde has been steadfast in her commitment to defeating inflation, which she calls “sticky”.

Looking at the overall inflation picture for the Eurozone, it will be a significant amount of time, possibly well past the end of this year for inflation to be brought back to the Central Bank’s target of an average of 2%.

The hawks on the Governing Council have very little to say about the continued raising of short-term rates, presumably as they believe that there is a tacit agreement among the region’s Central Bank Governors that the fight against high inflation will continue until it is won.

The minor achievement of the doves whereby the size of an increment of individual hikes has been reduced to twenty-five basis points instead of fifty mostly means that the hikes will go on for long.

Luis de Guingos, the Governor of the Banco do España, has taken on the role of spokesman for the dovish section of the Governing Council and has been speaking recently of a pause in hikes being imminent, although the markets still believe that there will be at least two more hikes before the ECB can consider a pause.

The lack of a fiscal union means that Eurozone Governments are continuing to inject support into their own economies which adds to the overall inflation rate of the entire group.

The fall in wholesale energy prices may begin to deter those actions and this may see the overall rate of inflation begin to fall.

The euro remains under some pressure from the dollar as the latter benefits from some risk aversion. It fell to a low of 1.0760 yesterday and closed at 1.0770.

Have a great day!