5 January 2023: How will Sunak cut inflation by 50%

The Prime Minister provided a keynote New Year speech yesterday in which he made three promises but felt unable to place a time limit on any of them.

He vowed to cut the inflation rate in half, reduce NHS waiting lists and grow the economy. This is obviously a wish list for any Prime Minister, but he was painfully devoid of any details as to how his goals will be achieved.

To reduce NHS waiting times, he will need to produce more doctors, nurses and hospital beds. Currently, the NHS is losing staff despite a pledge to recruit 30k more, while in order to deliver the 7k new beds that have been promised by his health minister, they will need to expand the recruitment exponentially. This could take a revision of his refusal to consider a Swiss style agreement with the European Union that could allow health workers to be recruited.

In order to grow the economy, tax cuts will be needed, but there has been no indication of this happening from his Chancellor. Jeremy Hunt met with business leaders yesterday to explains the Government’s plans to provide support to them during the next financial year.

This sounds more like a package of emergency measures rather than a plan for growth. There is little prospect of a positive quarter of GDP before the final quarter of this year, and that is only a very remote chance.

Finally, bringing inflation down by half from where it is currently is the stuff of fantasy. Again, it is likely that prices will begin to normalize later in the year, but that will be a natural process as the economy slows. The figures for food price inflation that were published yesterday were the highest of record at 13.3% for December, with very little prospect of them falling between now and March.

In order to cut the rate of inflation in half, the Government would need to influence the independent Bank of England to hike rates even more significantly. The alternative is a massive package of fiscal measures that the country simply cannot afford.

Sunak’s speech was generally well received by all, albeit with plenty of scepticism. The Leader of the Opposition will have the opportunity later today to reveal his alternative plans to get the economy moving again. He is almost certain to propose how the wave of industrial action could be settled, which would likely involve giving in to their demands.

This would be welcome if he is able to confirm how it would be funded.

The pound either took Sunak’s speech, either in its stride or with a pinch of salt. Either way, Sterling was unmoved. It ended the day at 1.2058 against the dollar, having earlier climbed to 1.2087. In order to set a tone for traders, it needs to move further away from the pivotal 1.20 level in either direction.

The minutes of the latest FOMC meeting were published after the markets in Europe and the UK were closed last evening.

They provided fresh insight into the thinking of the members of the committee, but were far from positive about the Fed’s future course of action.

In summary, the minutes showed that the Central Bank is likely to remain guided by economic data until it can be certain that inflation is genuinely falling, and that fall is in response to tighter monetary policy.

If anything, the minutes displayed a rather more hawkish outlook than was seen in the previous set of minutes. There was distinct concern regarding the pace at which inflation is falling, despite the fact that rates are now well into restrictive territory.

The feelings of the committee could even be described as surprise that inflation is not falling in far larger increments.

The set of projections for the economy that accompanied the minutes show that the FOMC expects inflation to end 2023 marginally higher than had previously been expected and this, according to analysts, precludes any cut in short-term interest rates this year.

Rates are now widely expected to reach 5%, or even a little higher, this year, and this notion was widely supported by the committee.

Inflation is now expected to end the year at 3.1% versus the projection in the previous estimates of 2.8%. The market is overall a little more dovish on inflation, as price pressures within the economy have fallen.

It may be that Jerome Powell and his colleagues on the FOMC, having had their fingers burned once in this cycle, are determined that it won’t happen again.

They are of course running the risk of driving the economy into a recession, but that risk is only considered moderate and even then, any technical recession is likely to be shallow.

The first of the monthly employment figures were released yesterday. The JOLTS data for job openings was surprisingly strong. There were still close to 10.5 million openings in December, and the November number was revised a little higher.

The dollar index was not particularly impressed by the slightly more hawkish tone from the FOMC, and appears to be waiting for tomorrow’s December employment report for encouragement. It fell to a low of 103.82 yesterday and closed at 104.26.

It is likely that the next meeting of the Governing Council of the ECB is going to open up several old wounds, as the two largest economies within the Eurozone have both reported lower headline inflation numbers for December than have been seen so far during the current cycle of tighter monetary policy.

Following on closely behind Germany’s surprising fall in inflation came France, which hasn’t been suffering as much as Germany, but a fall in prices is nonetheless welcome.

While it is unlikely that the Central Bank will taper the size of its increases in short-term rates, having only just touched neutrality, it would be very difficult to see a jumbo hike of seventy-five points at the next meeting.

The President of the Austrian Central Bank was clear after the previous meeting that the choice facing the committee had been either seventy-five or fifty basis points, and his tone suggested that the eventual choice had been something of a compromise.

Italy is likely to expect that if there is to be any rise this month, it will be twenty-five basis points, although fifty points may be again seen as a compromise.

If the Central Bank begins to hike by smaller increments now, the market will be led to believe that it isn’t really serious about its inflation fighting credentials and the euro will suffer significant damage, which will in turn lead to higher inflation.

While Christine Lagarde may express sympathy for Italy and its fellow highly indebted neighbours, she will need to remain pragmatic in her decision-making process.

Yesterday the euro was more a product of developments elsewhere, and it is likely to remain so for the rest of this week. Yesterday, it regained half its fall from the previous session, reaching a high of 1.0635 closing at 1.0603.

Have a great day!