2 December 2024: Tax “time bomb is dragging confidence down

Consumer and Business confidence in the UK has fallen in the past few months as the market’s concerns over the tax plans of the new Government have taken shape.

Chancellor Rachel Reeves told the CBI’s Annual Conference that her Budget was a one-off event in which she “wiped the slate clean,” and she would not raise taxes again during the term of this Parliament.

It remains to be seen if she can keep that pledge since growth is not expected to provide the Treasury with the level of tax inflows to lower borrowing and maintain the ambitious funding she has announced for the NHS and other public services.

The Institute of Directors has said that the Budget will undermine the private sector and has already begun to slow investment which is vital to the Government’s plans.

The Institute of Directors’ economic confidence index, which measures business leader optimism in prospects for the UK economy, fell to -65 in November from -52 in October, the fourth monthly fall in a row.

That is the lowest reading since the record low of -69 in April 2020, and the second worst since the index began in July 2016.

As businesses begin to absorb the outcomes of the budget for their business plans, confidence has continued to plummet and is approaching the lows reached at the onset of the COVID-19 pandemic.

Far from fixing the foundations, the budget has undermined them, damaging the private sector’s ability to invest in their businesses and their workforces.

UK hospitality companies warned last month that some would be forced to close, while others would cut jobs and investment because of NIC increases.

Business leaders’ confidence also fell last month, the IoD reported the lowest since May 2020, leading to a fall in investment plans and headcount expectations.

The increase in employers’ NI contributions has meant that many large chains in the hospitality sector will revise plans to expand their workforce in the coming year and some are already talking about rationalization early in the New Year, which is traditionally a slow period in the industry.

Output data is due for releases on Wednesday with services predicted to be at 50, unchanged from last month, which may see the combined figure improve marginally.

The pound has entered the final month of the year on a positive footing. Market doubts that the Bank of England would cut rates this month have provided some support for the currency.

Last week it rallied to a high of 1.2750 and closed at 1.2745.

Data for manufacturing output will be published later today, and although the PMI index will remain in contraction, it is expected to have seen a significant rally. It is too early to say if this is the effect of President-Elect Trump’s threat to set tariffs on the import of finished goods or if it is simply the result of the election which has boosted business confidence.

Both the ISM and S&P manufacturing indices are expected to show an improvement over the last quarter.

Senator Bill Hagerty, said yesterday that he is supportive of Donald Trump’s plans to impose tariffs on several nations, including Canada and Mexico, pointing to the long history of the U.S. using trade as a “strategic tool” for decades.

Access to our economy is a privilege,” Hagerty said during an interview with NBC News’ “Meet the Press, “If you think about it, we’ve made access to this economy a strategic tool ever since World War II.”

“Right now, the United States has the most open market of any major economy in the world, we need to take a very hard look at countries that don’t have our best interests at heart, countries that are allowing our borders to be violated, and use those tariffs as a tool to achieve our ends,” Hagerty added.

Although monetary policy will remain the most significant driver of financial markets next year, with the Bank of England and the Federal Reserve expected to be a little more circumspect about the cuts as the ECB is virtually committed to a far looser policy well into the New Year, trade is likely to be a close second in the market’s thoughts.

Some economists are concerned that if Trump widens his “net of tariffs” he could harm the economy for the entire period of his second term.

While the tariffs on finished goods, particularly vehicles, will see inflation rise and this may encourage the Fed to leave rates on hold unless growth begins to fall rapidly, the U.S. still relies on the import parts for several areas of the manufacturing sector which will slow output and productivity just as it is beginning to pick up.

Later this week the November employment report will be published, preceded as usual by a slew of numbers for specific areas, like lay-offs, private sector employment and job openings.

The market is expecting a significant increase in the number of jobs created as factors like the Election and the inclement weather seen during November have abated. Anything above 100k new jobs will be seen as positive for the dollar.

Last week, the Dollar index suffered a mild correction, although it did fall below its short-term level of support. It fell to a low of 105.62 and closed at 105.73, although liquidity suffered from the Thanksgiving Holiday.

Although there is significant vocal opposition to a December meeting, several banks, including the economics team at J.P. Morgan believe that a sufficient majority of Governing Council members are in favour.

Although inflation in the eurozone increased to 2.3% in November, surpassing the European Central Bank’s (ECB) 2% target, there appears to be sufficient for rates to be radically cut as part of a drive to bring rates into supportive territory.

Despite the increase, market analysts anticipate the ECB will proceed with its planned interest rate cut during its December 12 meeting. The vote is likely to be close, but the doves now have the upper hand.

The uptick in inflation was driven by a 3.9% rise in the services sector, which includes costs for haircuts, hotels, and entertainment. Energy prices, in contrast, fell by 1.9% year-over-year, continuing to offer some relief to consumers.

Core inflation, which excludes volatile components like energy and food, remained steady at 2.7% for the third consecutive month, reflecting persistent price pressures in key areas of the economy.

Although the ECB has acknowledged that inflation is unlikely to be consistently at or below 2% before the start of the third quarter of next year, it is hoped that falling energy prices will see the fall accelerate.

The ECB president is calling for the European Commission to think strategically and engage in direct negotiations with the U.S. instead of considering how it will retaliate over the prospect of tariffs on its exports to the U.S.

Christine Lagarde believes that a “knee-jerk retaliation” will serve no one and could start a global trade war, in which global relationships outside the U.S. could also be damaged.

Trade disputes are often characterized by tit-for-tat, and she believes that Trump’s threat may be little more than an opening negotiating position. During his last Presidency, Trump constantly threatened legislation that would see the U.S. manufacturers be forced to repatriate their manufacturing capacity, but that led to nothing since the costs to U.S. businesses were considered prohibitive.

The divergence between the Eurozone and the U.S. is expected to continue during the first half of 2025, with the neutral rate that both the ECB and Fed are striving for considered to be significantly lower in Europe.

Although the markets are expecting the ECB to cut rates at every meeting until June, the Fed is expected to be more circumspect since it has the luxury of stable growth.

Last week, the single currency saw a marginal improvement, although that is expected to be temporary.

It rose to a high of 1.0597 and closed at 1.0582.

Have a great day!