5 September 2024: Reeves, the “Robin Hood” Chancellor

Parliament returned from its summer recess this week and saw the first Prime Minister’s Questions of the new session yesterday. The main topic of the byplay between Sir Keir Starmer and Rishi Sunak was the withdrawal of the pensioner’s winter fuel allowance, with Sunak likening Chancellor, Rachel Reeves, to Robin Hood, taking from pensioners and giving to train drivers.

In better news for those on a state pension, the “triple lock” will again be effective when calculating the amount by which pensions will rise from April next year. The increase is likely to be well above the inflation rate.

The rise is likely to be matched to average wage increases which have remained above the inflation rate.

The data for wage increases in the third quarter will be published early next week. The increase is expected to be around four hundred pounds for pensioners next year.

When Michael Saunders was a member of the Monetary Policy Committee, he was its most hawkish member. Therefore, it was somewhat of a surprise that in a note to investors in his current role as an adviser to a City Investment Firm, he commented that he expects interest rates to fall over the next fifteen months by more than the market is pricing in.

“Fiscal tightening and the reduced impact of the cashflow channel argue for a fairly rapid return to a neutral monetary stance, to prevent inflation falling below target over time,” Saunders believes.

The money markets are predicting that the base rate will fall to 3.75% by the end of next year and bottom out at 3.50%.

A normal “cutting cycle” would last around nine months historically but with Andrew Bailey still not feeling able to declare a victory in the war against inflation, Saunders expects the current cycle to last up to twice that time.

Saunders emphasized in this note that this is not a criticism of the MPC, since the future path of inflation is by no means certain, giving rise to his view that there won’t be a cut delivered this month.

The pound has had a mixed week as traders position themselves for the monetary policy meetings that are happening this month, with the ECB kicking things off a week from today.

Sterling rallied to a high of 1.3175 but was unable to sustain its gains and drifted back to close at 1.3146

Following the “manufactured drama” of the two political party conventions that have taken place recently, both Kamala Harris and Donald Trump have begun in earnest to campaign for the Presidential election which takes place two months from today.

While Harris is campaigning on a “no change” manifesto, no matter what Trump says he will without doubt shake up the White House.

The markets are concerned about the size of the fiscal deficit that Harris is going to allow to grow should she be elected. She is banking on the economy continuing to grow sufficiently for the additional taxes that are raised to offset the budget deficit.

Trump, on the other hand, is expected to slash Government borrowing, but it is possible interference in the independence of the Federal Reserve that is causing a high level of concern on Wall Street.

Trump says he wants a more direct role in how the Federal Reserve sets interest rates and suggested he could break with traditional policies when it comes to the Fed’s independence. This has set alarm bells ringing.

The market is driven by those who think they could do a better job of setting monetary policy than Jerome Powell, but very few, if any, have the power to insert themselves into the Fed’s considerations.

FOMC member, Raphael Bostic, the President of the Atlanta Fed, spoke yesterday of his view that the balance of risks between inflation and employment is balanced. He feels disinclined to agree that the war on inflation is at an end and calls upon his colleagues to still be vigilant.

He believes that although job creation is slowing. This brings the possibility of a soft landing further into the spotlight. He did, however, fail to comment on what he thinks a soft landing would look like in data terms.

The JOLTS data for job vacancies was published yesterday, and it showed that openings declined as firms slowly ease the number of new workers they employ.

Although the data showed the lowest number since 2021, the market was not surprised as the number of openings fell to 7.67 million from 7.91 million in July, which was revised lower.

The dollar reacted poorly to the data which the market considers to be another factor which may lead to a fifty-point cut in interest rates this month.

The index fell to a low of 101.24 and there was little buying interest at lower levels which led to a close of 101.29.

ECB Governing Council Hawk, Isabel Schnabel, has called upon her colleagues on the Council to remain vigilant against the possibility that inflation could well “flare up” again should they decide to cut interest rates “excessively” in the coming months.

It is well known that Schnable will vote against a hike at next week’s rate-setting meeting, so it is difficult to gauge what excessive cuts look like.

She cited the risk that inflation could fail to achieve its two per cent target, although several of her colleagues, including Philip Lane, believe that it could easily overshoot if rates are not cut.

While recent data supports the ECB’s optimistic outlook for achieving its inflation goal by the end of 2025, high service price inflation could impede overall progress. She emphasized that the path to price stability relies on several critical assumptions, and therefore, monetary policy adjustments should be gradual and evidence-based rather than automatic.

Joachim Nagel. The President of the Bundesbank has also cautioned that the Bank should not be on “autopilot” during monetary policy discussions, cutting rates simply to keep up with the Federal Reserve.

Although a rate cut is still in the balance at next week’s meeting, any talk of a fifty-point cut in reaction to fears of a significant slowdown appears to have gone away.

One reason for caution is the publication of producer prices yesterday. Although “factory gate inflation” fell on a year-on-year basis to 2.1% in July that was down from a 3.3% fall in June. Month-on-month producer prices rose by 0.8% in July which will be a concern for consumer price inflation a little further down the line.

The Influential Kiel Institute for the World Economy reported yesterday that it does not expect the German economy to report any growth at all this year and is likely to contract by 0.1% overall.

The think tank previously expected moderate growth in gross domestic product over the year.

Unemployment will also rise to 6.0% this year and 6.1% in 2025, the institute, known as IfW, said. That raises the prospect of a fresh recession, typically defined as two or more successive quarters of declining GDP.

The euro was positively affected by further data that pointed to a fifty-basis point cut in U.S. interest rates.

The single currency rose to a high of 1.1095 and closed at 1.1082.

Have a great day!