6 August 2024: Reeves is banking on the economy

It is believed that Rachel Reeves has already been informed by the Office for Budget Responsibility that the tax increases that she has recently alluded to may not be necessary given the pace at which the economy is recovering.

During its first month in office, the Government has been “all about” the economy, making no secret of the fact that it blames the Conservative Party for all the issues that it has uncovered.

Both Rishi Sunak and Jeremy Hunt were adamant in the run-up to the election that they had a plan for the economy and that it was working.

Data published yesterday shows that the economy has improved to such an extent that it is now outstripping France and Germany in the significant services sector.

Services output improved to 52.5 from 52,4 in July, contributing to the S&P Global/SIPS Composite PMI climbing to 52.8, well ahead of the level that denotes an expanding economy.

It is likely that, given her “starring role” in the Government’s initial efforts to prove itself. Reeves will take something of a backseat as she prepares for the Autumn Statement and her first Budget.

The spotlight is now falling on Reeves’ colleague Yvette Cooper, the Home Secretary. Doubtless, she has been surprised by the vehemence of the current rioting occurring up and down the country.

Given the fact that the rioters are well organized, being able to travel unchallenged from cities as geographically diverse as Bristol and Sunderland, is prompting questions about who is behind the right-wing dissidents.

Nigel Farage, the Leader of the Reform Party, believes that it is a reaction to the election result where his Party gained over four million votes but only gained five seats in Parliament, causing its voice not to be heard about mass immigration and asylum.

The role of social media in allowing the easy spread of direction to the rioters will need to be investigated.

The Prime Minister is making speeches about law and order and has already put several initiatives in place, but it is clear from news reports that the police are powerless to quell the demonstrations, which quickly turn violent.

The fear that the U.S. may be on the verge of slipping into recession is affecting global markets. Having rallied to its highest level since early June on Friday, Sterling “took a breather yesterday”, as it became clear that the Bank of England will most likely “keep pace” with the Fed in easing monetary policy.

The pound retreated to a low of 1.2710, but quickly recovered to close at 1.2775.

Over the years, the Federal Reserve has gained a reputation for not shying away from tough decisions when action is needed to avert either an inflationary spike or a downturn which appears to be leading to a recession.

Although under Jerome Powell it has maintained that reputation, reacting positively to the fiscal support that the Biden Administration pumped into the economy during and just after the Pandemic, it now appears that they may be called on to take decisive action if the economy is going to avoid slipping into a recession or at the very least suffering a significant downturn.

Economists, especially dovish ones, tend to “bandy around” the “R” word too often to characterize an economic slowdown, and the pace with which the turnaround has happened shows the effect of the summer lull and what can happen on a slow news day.

The July employment report unquestionably showed that the economy was faltering, but that has been the Fed’s target over the past year as it has strived for a soft landing.

A headline figure of a little over 100k new jobs created for July has been a “shock to the system”, yet it is hard to imagine that 60% of economists polled yesterday truly believe that the Fed will execute an emergency rate cut within the next two weeks, as was mooted yesterday.

Two Regional Fed Presidents. Mary Daly from San Francisco and Austen Goolsbee from Chicago, both spoke yesterday of the fact that the economy is slowing, but a recession is a “long way off” and the Fed has the tools to manage the situation as it evolves.

No one can deny that a global sell-off in equities has not been on the cards for some time. The rise of tech companies in the U.S. where the entire market is being driven by a few names, always leads to a significant drop, as the “elasticity” of the market is stretched to the limit.

When we in the UK see the word recession, it takes us back to the late seventies or early eighties, which were strewn with industrial degradation and trade union militancy.

None of that is likely to take place in any of the G7 nations, and the sell-off is little more than a healthy correction, although that does sound a lot like Powell’s “transitory inflation” comment.

The dollar has also seen a “healthy correction” which is due as much to a lack of market liquidity as it is to recession fears.

Yesterday, the index fell to a low of 102.17 but bounced to close at 102.74

The rise in the value of the Euro may well be sufficient to ally the ECB Governing Council’s fears about a spike in inflation, but it may not be sufficient to cause members to vote for a rate cut at the September meeting, since, by then, the markets may well be “back to normal”.

Data published yesterday for services in the region showed that output remained at a healthy level of 51.9, although it also showed how services are “carrying” the rest of the economy since the composite figure was only just above the line which separates expansion from contraction at 50.2. Still, this was a marginal improvement from June.

Both France and Germany saw their composite indexes of Services and Manufacturing output combined remain “below the line”, both at 49.1

The eurozone economy has now fallen well behind that of the UK since there is a considerable divergence in economic output taking place.

While the UK is still undoubtedly suffering the effects of Brexit, it may well be that the Government would do well to try to either shy away from closer links to Brussels or, if it considers such a move as vital to its future, negotiate far better terms.

Given the stories emanating from the U.S. currently, Isabel Schnabel may be proved correct in her assertion that monetary policy in the two G7 members won’t diverge too far.

The Sentix Report on Investor Confidence for August was published yesterday and will have made an unpleasant reading for Christine Lagarde and her colleagues at the ECB.

Confidence fell to -13.9 after a read of -7.9 in July. The Eurozone economy is led far more by corporate confidence than either the UK or the U.S., which has a far greater reliance on the consumer.

Natural gas price shocks have an increasingly important impact on eurozone inflation, although still not as much as oil price fluctuations, fresh research published by the European Central Bank showed on Monday.

Natural gas prices soared at the start of Russia’s war in Ukraine in early 2022, helping drive inflation into double digits by the autumn of that year and setting off the ECB’s steepest rate hike cycle to date.

As gas prices have fallen, the ECB has been able to embark on a far less hawkish path.

The Euro has benefited from market fears of an emergency rate cut taking place in the U.S. It rallied to a high of 1.1008 yesterday but ran into significant selling interest and quickly fell back to close at 1.0953.

The Fed is more likely to use words rather than actions to allay market fears, in which the single currency may have seen its peak in the short to medium term.

Have a great day!