26 September 2022: Government gambles on growth

GBP – Public borrowing set to skyrocket

Sterling has fallen to an all-time low overnight as the financial markets give their opinion on the Government’s programme of tax cuts, and its ability to pay for them.

Liz Truss and Kwasi Kwarteng are gambling that their policies which were announced last week will stimulate growth to such an extent that the additional taxation will be sufficient to enable the Treasury to pay down the additional borrowing that will be necessary in the short term.

The Treasury will have to borrow close to an additional hundred billion pounds to pay for the tax cuts that are the largest for close to fifty years.

In a series of interviews on TV news channels over the weekend, the chancellor argued that the announcements made were not a gamble but a calculated part of a plan to stimulate growth that will turn around inward investment that has been falling for the past ten years.

The key features of the programme are the scrapping of the highest rate of taxation that is charged on earnings over £150,000. The basic rate of taxation will be lowered to 19p in the pound. This measure was already in the pipeline, having been announced by Rishi Sunak last March, although its introduction has been

The Labour Party, who are holding their annual conference this week, immediately announced that if they win the next election, the cut in the highest rate of taxation will be reversed.

Also announced by the Chancellor last week was the reversal of the increase in National Insurance contributions for both employers and workers.

Analysts have labelled the programme of tax cuts a huge unfair risk as the greatest beneficiaries are the top 1% of earners while the lowest pad will finish up worse off in the short term with those benefits not rising until next year while, meantime, they must contend with higher energy costs now, despite the lowering of the energy cap.

The strategy of the Government’s policy is to stimulate the flow of money through the economy via trickle-down economics which have been tried and failed before.

This is a massive gamble so relatively close to a general election. Even if it is starting to work by the time the election comes around, it is unlikely to erase the memory of the short to medium term pain that has been inflicted on the electorate.

The pound has fallen to a low of 1.0339 and is currently (0445 BST) trading at 1.0479.

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USD – New set of disruptions will affect the economy

Jerome Powell spoke late last week about the new normal that is driving the economy.

He believes that soaring inflation levels and the slowdown in economic growth afflicting the country now is in large part due to adjustments in the economy as it emerges from the Pandemic.

This may be true, but the sledgehammer effect of the series of interest rate hikes that have taken place recently have exacerbated the virtual collapse of equity markets.

The President of the Atlanta Federal Reserve, Raphael Bostic spoke at the weekend of his belief that the Fed can tame inflation, bringing it back close to its 2% target without inflicting severe pain on the employment market.

He said that any rise in unemployment will be less than has been seen in similar situations.

With interest rates now at 3.25% and expected to hit 4% at the next meeting, FOMC meeting the Central Bank’s aggressive tightening of monetary policy has taken rates well into restrictive territory.

It is only the latest hike that has crossed the line from accommodative into restrictive, but it has taken six months to reach the stage where monetary policy is having a significant effect.

The September employment report is likely to show a significant fall in the number of jobs created.

The Fed’s objective is to lower demand in order that prices can stabilise, but the risk is that borrowing costs will result in too severe a slowdown in the economy. Bostic went on to say that every sea change in policy carries a risk and emerging from an era of low interest rates will have a degree of pain.

This week, data for durable goods orders which is a signal of longer-term growth in the economy and new home sales which are directly affected by monetary policy will be released. Both are expected to turn lower, but it is the rate of change that will draw the attention of the Central Bank.

The dollar continues to attract buyers as the Fed continues a path towards tighter monetary policy,

The dollar index rose to a high of 113.23 last week and closed at 113.02.

EUR – Central Bank wants to be less transparent

Having been daily open about the size and timing of the series of interest rate hikes it has entered recently, the President of the ECB, Christine Lagarde, believes that it needs to be more cautious in providing guidance to the market as such guidance if reducing the effect of the policies,

There are clearly continuing issues with the new tools that have been promised that will ensure that the gap between pay between Germany and the most indebted nations of the Eurozone doesn’t blow out to unmanageable levels.

Even though meetings between the technocrats involved being held behind closed doors, the breakdown in negotiations is clear since the wealthier nations do not wish to guarantee the weaker ones any longer with no material benefit.

No matter how the package is labelled, it means that the ECB and therefore the wealthy frugal five will be expected to prove support for weaker economies with no guarantee that they will subsequently abide by the rules.

In Italy, where an election to find a new Prime Minister was held yesterday, there is already unrest due to the inflated cost of living and the inability or unwillingness of the Government to provide further support.

The authorities in Brussels are running out of patience with the inability of Italy to control its budget deficit which is currently running at 9%, three times the rate that Brussels demands, while its debt to GDP ratio is around 135%.

In the election held three years ago, the Brothers of Italy Party were a minnow, gaining less than four per cent of the vote. Now thanks to a set of simple policies that appeal to voters and a young female leader who has captured the imagination of the electorate, they stand on the verge of an historic victory.

Their far-right policies that put Italy and Italians first have really galvanized voters who believe that they have been let down by the inability of Giuseppe Conte’s Five Star Movement and Matteo Salvini’s League, who have vied for power recently.

As the second-heaviest user after Germany of Russian energy, Italy faces a tough few months, but the policies of Georgia Meloni’s give them a degree of hope that has been missing since the Pandemic first struck.

The euro has fallen to a low of 0.9553 this morning and is currently trading at 0.9633.