29 July 2024: “Tax raids” are expected

Rachel Reeves will inform Parliament later today of the audit result into the country’s finances she instigated on the first day she arrived in the Treasury following the election.

She found a twenty billion pound “hole” in the previous funding of its long-term projects and its “in-year” budget.

She will tell MPs that she will not step back from making the important decisions to get the country back on track, but she will lay the blame for the dire situation squarely at the door of Rishi Sunak and Jeremy Hunt.

She will say that the Conservatives spent money “like water” and made commitments to several projects without having the funding in place. Infrastructure projects like the “Stonehenge Tunnel”, and other ambitious road and rail developments will have to be scaled back or shelved since the funding is not available.

She will go on to say that the previous Government was irresponsible in its handling of the economy, which will lead her to either raise taxes or make spending cuts, together with Hunt’s claim during the election campaign that while his Party would lower taxes, Labour would increase them.

Hunt said that the Office for Budget Responsibility made a six-monthly audit of the country’s finances and did not find any gaps in the allocation of funding.

Whoever is right, it begs the question of funding for future investment. Reeves and her colleagues have constantly said that the economy would grow to such an extent in the coming months/years to allow it to invest in major infrastructure projects like onshore windfarms and upgrades to both track and rolling stock in the newly nationalized rails companies.

Doubtless, Hunt will allude to the same idea, although he will have some justification since his “plan” for the economy has been working given that since the start of the year, the economy has been growing at a rate above the predicted by both domestic and overseas think tanks.

At some point, Reeves will have to do more than promise that things will get better, the clock is ticking on her honeymoon period, and she will face criticism outside Parliament if she fails to deliver an economy that is performing better than it was before July 4th.

The Monetary Policy Committee will meet this week, and while there is a chance that a rate cut will be agreed, it is expected that they will hold off until September, to allow wages and core inflation to fall further.

Sterling lost a little ground last week, but stayed within its short-term range, It fell to a low of 1.2850 and closed at 1.2867.

Under “normal circumstances”, this week would be considered pivotal in terms of the U.S. economy with the FOMC meeting tomorrow and Wednesday to consider monetary policy and the July employment report due to be published on Friday, with other data relating to the jobs market due throughout the week.

However, given the “summer lull” is now in full swing and Fed Chairman, Jerome Powell has already provided advance guidance to the market that a rate cut won’t take place until September, at the earliest, there is unlikely to be a significant rise in the level of market volatility.

While there is anecdotal evidence that the economy is beginning to slow down, neither of the two areas that the Fed is primarily responsible for, prices and employment, are providing indications that monetary policy needs to be loosened.

It is expected that the headline rate of job creation in Friday’s employment report will be between 125k and 175k, with job losses and public sector employment also pointing to a “cooling off”.

Anything above 200k will place a rate cut in September in doubt and see the dollar strengthen, given that both the ECB and Bank of England are expected to cut rates then.

There will be no celebration of the anniversary of the Fed ending its cycle of rate cuts when the FOMC meets this week.

It was wholly unexpected that a year would go by without any change to interest rates since inflation was still “hot” when the pause in rate hikes was announced, while by the end of 2023, dire warnings were being published that the economy was on the verge of slipping into recession.

The level of GDP growth in the first two quarters of the year has been encouraging and there is little talk of recession now, despite Elon Musk commenting last week that the country is close to bankruptcy.

For economies, like households, bankruptcy only happens when sources of funding run out and so far, that is still unlikely for the U.S.

Despite the huge advances made by China in both the numbers and quality of their EV production, the U.S. The EV market is continuing to see some improvement of its own.

One area where the U.S. has outstripped China is in the production of Electric RVs.

Recreational Vehicles are continuing to grow in popularity, allowing families to holiday without needing to increase their carbon footprint by taking flights, and the new generation of electric vehicles have improved technology which significantly increases their range.

The dollar’s value was virtually unchanged last week. It traded between 104.55 and 104.08 and closed at 103.33, just one pip higher than the previous week’s close.

A rate cut by the ECB when its Governing Council returns for holiday in September is not quite as certain as the previous cut made at the June meeting but given the path of inflation and wages recently it is more likely than a cut in either the UK or the U.S.

Rare cuts have become less about economic growth and more about inflation and wages ever since the three major G7 Central Banks paused and then halted their cycles of rate hikes last year.

There was always likely to be some “lag” at the end of rate cuts, and wages beginning to fall, as wage claims took their lead from inflation, which began to fall rapidly as G7 economies adjusted to higher rates and then became “sticky” during the early part of this year.

The ECB faces the greatest pressure to cut rates for the second time in this cycle, given the parlous state of the Eurozone economy. Its biggest economy, Germany, published output data last week which points to it having slipped back into inflation.

The Eurozone is still in its infancy, having been in existence for less than thirty years, but unless it takes notice of the structural issues that it continues to ignore, it may be too late even at this point to change.

It is often said that a monetary union can only be effective if it is paired with a fiscal union, but that will be difficult to achieve since a majority of Eurozone members see fiscal policy as a “get out of jail free card” when they want to dilute the effectiveness of rate hikes.

Christine Lagarde is seen by many as too much of a diplomat and too little of a bureaucrat to make an effective President of the ECB, and while the President of the European Union must be an effective diplomat, Ursula von der Leyen needs the support of a Eurozone-wide Finance Ministry.

Isabel Schnabel, the most influential among the hawkish policymakers who drove the ECB’s steepest-ever streak of interest rate hikes in 2022-23, stuck to her cautious tone even as many of her colleagues were opening the door to more rate reductions.

We continue to expect inflation to gradually converge to our 2% target over next year,” Schnabel told reporters last week. However, persistent services inflation shows that the ‘last mile’ of the fight against inflation is particularly difficult.

While headline inflation continues to fall close to the ECB’s 2% target, some data remains “out of line”.

Schnabel, while being very influential at the ECB, may well see herself outvoted at September’s meeting.

The euro has remained in a narrow range for the whole of July. Last week, it weakened marginally falling to a low of 1.0825, but recovered to close at 1.0857.

Have a great day!