29 August 2024: The SNP and Tories were profligate – Reeves

Rachel Reeves has expanded the range of blame for the apparently parlous state of the country’s economy to include both the Conservative Party in England and the SNP in Scotland.

A report published yesterday by the Scottish Fiscal Commission, the equivalent of the Office for Budget Responsibility north of the border, warned that the current Scottish Government run by the SNP will need to make some tough decisions if it is to balance its budget.

The Chancellor commented that the governments on both sides of the border simply deferred any form of fiscal prudence, leaving the mess for the incoming Labour Government to deal with, since they both knew that the party would win the July election.

Labour is already becoming proficient at leaking its more controversial plans to “test the water” of public opinion. After the pensioner’s winter fuel allowance withdrawal and the retention of the two-child benefit cap, it is now “rumoured” that Reeves is considering the withdrawal of the fuel subsidy, which is worth 5p a litre to forecourt petrol prices.

The Prime Minister met with the German Chancellor, Olaf Scholz, in Berlin yesterday. They discussed a “reboot of the relationship between the UK and mainland Europe’s largest economy.

He was at pains to say that the basic relationship with the EU was now set in stone, and there would be no re-evaluation of Brexit, despite calling for a second referendum when he was in opposition.

In a joint press conference, Starmer spoke of several areas where the UK and Germany could potentially cooperate, including the thorny subject of illegal migration, which continues to “plague” the country.

One area over which he stood firm was the possible deal to allow under twenty-fives free access to live and work in the UK. He sees no change being made to any part of the “four freedoms”.

Over the next two months, the markets will be mostly driven by speculation over two main topics: the Budget and the possibility of further interest rate cuts.

It seems that the government intends to drip-feed its spending and taxation plans to the market, while MPC members will make their position on rate cuts clear over the next few weeks. Alan Taylor, the MPCs newest member, will be constantly badgered by the press to find out his voting intentions and his overall feelings about monetary policy.

The pound looks likely to stay strong over the same period as the economy may not require rate cuts given the level of growth that was seen over the first two quarters which is likely to have extended into the third, allowing the Bank of England to balance driving inflation down with help for the cost of living.

Yesterday, Sterling lost all the gains it made on Tuesday but is still in an uptrend. It fell to a low of 1.3167 and closed at 1.3193.

The FOMC appears to have split in two at its most recent meeting, with a significant number of Regional Fed Representatives voting for a rate cut while permanent members of the Committee and just two Fed Presidents voted for rates to remain unchanged.

The two “outliers” were New York and Chicago.

Although it appears that he voted for a cut, Atlanta Fed President Raphael Bostic seems to have retained his hawkish outlook. This week, he commented that inflation still has more room to decline and employment is likely to remain at historically elevated levels.

He would like to have the benefit of more data before making his mind up about a September rate cut.

His wish will be granted since the final cut of Q2 GDP and the July personal Consumption Expenditures will be published this week, while the August employment report and Consumer Price inflation will both be published before the FOMC meets again.

Having seemingly thrown his weight behind a rate cut at the September meeting, it is expected that Jerome Powell will be able to persuade the permanent members, who have been constantly more hawkish than the Fed Presidents, that the time for a cut has finally arrived.

The questions about comparative monetary policy decisions will be answered over the next month. While rate cuts are expected to take place next month, what happens after that will exercise market commentators’ minds.

The economists at J.P. Morgan believe that a cut next month will presage two more before year-end and a further cut early in the New Year.

The ECB faces the dilemma of matching the Fed or seeing its economy fall into a deep recession, escaping from which may take the first two quarters of 2025.

The dollar index has begun its recovery from the steep correction it has experienced recently.

Yesterday, it rallied to a high of 101.18 and closed at 101.06.

Over the past eighteen months, while G7 Central Banks have been tightening monetary policy and keeping rates at historical highs to combat inflation, the ECB has found itself constantly “behind the curve, firstly retaining its level of support for economies most hit by the pandemic and then only cutting rates last month, even then against the “better judgement” of the most hawkish members of its Governing Council.

While a rate cut by the Federal Reserve was “baked in” by Jerome Powell’s speech in Jackson Hole last week, and the Bank of England can afford the “luxury” of making sure the battle with inflation is at an end before cutting rates again, given the extraordinary performance of its economy, the ECB is facing economic pressure to cut rates as its economy falls ever closer to a recession.

There appears nothing that Germany can do to avoid a recession since its economy contracted in the second quarter, and the data published, so the rate for the third quarter appears to predict a similar result.

Although several Eurozone economies are faring well, their aggregate growth levels barely match the falls in German activity and output.

Although inflation is falling in Germany, the level of wage demands is still higher than the Bundesbank would like, causing BUBA President Joachim Nagel to comment this week that although rates have been lowered once already, there is no such thing as an “autopilot” for monetary policy and each decision must be made on the merits of the situation, which is a long-winded way of saying he will be guided by the data.

However, he did concede that if data for August is similar to July’s, then a rate cut will be possible.

Having met UK Prime Minister Keir Starmer for the first time in an official capacity yesterday, German Chancellor Olaf Scholz is in the awkward position of needing the UK more than the UK needs Germany. Although Starmer is looking for ways to boost the UK economy, and cooperation with Europe’s largest economy is a good place to start, Scholz has bemoaned the last of contact between Brits and Germans which have fallen to their lowest in decades.

The Euro has seen its gains made over the past three weeks begin to be eroded as comparative growth rates are taking over from monetary policy as the main driver of financial markets.

Yesterday, the Euro fell to a low of 1.1105 and closed at 1.1119 as recession fears gradually rose in Europe.

Although an economic contraction has threatened and, been ignored before, the inflation picture is vastly different now compared to the third quarter of last year and this may lead to more rate cuts from the ECB.

Have a great day!