2 October 2023: Tax cut possibilities will excite Tories

The Conservative Party Conference gets under way this morning in Manchester. It is likely to be the last one before a General Election is called.

While a majority of the Party faithful will want to talk tax cuts which Chancellor Jeremy Hunt has hinted recently may be possible either in his Autumn statement, or in the Budget next Spring, Prime Minister Rishi Sunak speaking on TV yesterday wanted to concentrate on bringing inflation down.

The recent changes to the Government’s green agenda and to “motorist friendly” policy amendments that have been announced are clearly the first of many initiatives designed to woo voters.

New figures released by the Office for National Statistics reveal that the economy grew by far more in 2020 and 2021, showing that the recovery from the pandemic was far stronger than previously thought.

The rate of growth over the past eighteen months has been as previously announced, with the second quarter remaining at 0.2%, although GDP for the first quarter was revised marginally from 0.1% to 0.3%.

Overall, the economy is around 2% larger than had previously been announced. In financial terms this equates to about fifty billion pounds. The uplift in growth shows that certain sectors of the economy are performing far better than others.

Improvements in data delivery produced better growth in the professional services while the medical sector continued to struggle with supply chains not yet catching up with pre-pandemic activity.

In terms of a comparison, the UK still trails behind the Eurozone as a whole, but when Brussels’ growth rates are broken down nationally, the UK is faring better than two of its largest economies in Germany and France.

The interest rate increases that have been delivered by the Bank of England stretching back to December 2021 will have had a gradual effect on demand, and those agreed in the past six months will not have fully worked their way through yet.

Last week saw no tier one economic data released, leaving the market to continue to consider the ramifications of the pause in rate hikes by the MPC at its recent meeting. Given the likely increase in headline inflation given the rising oil price there is still expected to be another hike before rates can be considered to have peaked. However, it is considered unlikely that Andrew Bailey will actually announce that the cycle of hikes has ended.

The pound remained under pressure from a strongly favoured dollar, it fell to a low of 1.2110, which brought the long-term support at 1.2000 into consideration but recovered strongly as the dollar faltered to close at 1.2199.

Yet another game of “chicken” between Congress and the Biden Administration came to nothing as a temporary agreement was reached for the Federal Government to remain funded for the next forty-five days.

The market knows and understands the potential severity of a shutdown of Government offices, so the threat of it happening will always cause volatility in the market. The day investors ignore the possibility is likely the time when the “nuclear option” is delivered.

The good news for Federal employees whose pay cheques are again guaranteed, was not such good for the people of Ukraine. As part of the agreement, four billion dollars of fresh funding has been postponed. This is expected to be agreed down the line as President Biden is due to reconsider the country’s support for Kyiv.

Coming off their worst month of the year so far for equities, the new quarter is expected to usher in some headwinds for the economy.

The UAW strike has expanded. It now includes workers at Ford and General Motors but so far Stellantis has been spared since fresh negotiations are progressing well.

Tesla is due to report quarterly deliveries this week with numbers of new cars deliveries expected to fall from 466k to 456k, a trend that is likely to become significant across the industry in the fourth quarter should the strike continue for any length of time.

Employment reports for September will be published this week, with new private sector jobs and job openings preceding the non-farm payrolls data.

Before that output data for both manufacturing and the service sector will be published. While manufacturing remains in contraction it is expected to have seen a marginal improvement from 48.9 to 49 while data for the service sector, due for release on Wednesday, will show continued healthy expansion, coming in at 53.6, marginally lower than in August. This can be accounted for by the loss of a day due to the Labor Day holiday.

Jerome Powell and his FOMC colleague Patrick Harker are due to make speeches at a conference later today. It is unlikely that either one will want to make any predictions about either the employment rapport or the likely outcome of the next FOMC meeting which is still four weeks away.

The market’s early expectations for the NFP data are for a “healthy” fall in new jobs created to around 160k which will continue to drive the expectation for a soft landing for the economy.

The dollar had a mixed week. It is still supported by the robust performance of the economy, but as with all trends, its advance is never going to be linear as traders continue to book profits.

Last week the Dollar Index rose to a high of 106.83, its eleventh consecutive positive week, but drifted lower to close the week at 106.16.

The harmonized inflation data that was delivered on Friday pointed to the ECB being able to consider a pause in its cycle of interest rate hikes that has now lasted fifteen months.

The core rate of inflation fell from 5.3% in August to 4.5% last month, while the headline also fell from 5.2% to 4.3%. The fall in the headline is only expected to be temporary as it will be affected by the rise in the oil price.

While the rate of inflation is still well above the ECB target, the data provides at least some encouragement for the doves on the ECB’s Governing Council who want the cycle of rate hike to be paused if not ended altogether.

The more hawkish members like Austria and Latvia have given up any pretence at being data driven, believing that the ECB needs to avoid inflation becoming ingrained in the Eurozone economy.

Growth in most of the Eurozone remains hard to come by with several members staging at a period of stagflation. Germany and Italy have already seen a recession this year, while France is teetering on the brink despite a recent improvement in its rate of inflation.

There will come a time, and it is rapidly approaching, when interest rates are clearly restricting growth, and the effect of further rises will be potentially devastating for the economy.

Germany, which has suffered more than most from both rising inflation and the energy crisis that peaked in the summer, has the advantage of being able to “kick start” its economy by “deficit funding”. Germany has a considerable war chest via its budget surpluses and now stands able to repeat the dose it used during the Pandemic.

The more conservative members of the Government have a similar aversion to borrowing as they do to rising inflation and while the situation is serious, they do not believe that it yet warrants massive borrowing.

As Germany stands on the brink of its second recession this year, it is hoped that it will be as shallow as the first, but with the rest of the region now under the severest of pressure, it may not be as easy to escape a lengthier downturn this time.

The Euro remains under the severest of pressure as the investors and traders lose faith in the ECB and its one-dimensional approach to the economy.

It fell to a low of 1.0488 but bounced back to close at 1.0573 as it further delayed its seemingly inevitable date with parity versus the dollar.

Have a great day!