7 August 2024: Taxes will increase in October

Andrew Bailey has presided over the setting of monetary policy for the UK in one of the most tumultuous periods in the country’s history since the Second World War.

The Governor of the Bank of England is appointed for a maximum of two four-year terms and despite several calls for his departure, he is keen to see the job “through to the end.”

Having dealt with the implementation of the country’s decision to leave the European Union, the Pandemic, raging inflation and Liz Truss’s brief yet calamitous period of “budgetary madness,” history should treat him well.

In his first interview since the MPC voted to cut interest rates by twenty-five basis points, Bailey confirmed that he is keen to complete the second of his two four-year terms.

However, he was criticised for raising interest rates too slowly, as the effect of the elevated level of fiscal support and the Russian invasion of Ukraine drove energy and foodstuff prices to historically high levels.

The Bank of England was the first of the G7 Central Bank to raise interest rates, in December 2021, but unlike the Federal Reserve or the ECB, it kept the incremental increases to twenty-five basis points for the entire cycle.

This drew criticism from economists and market commentators who, with the benefit of hindsight, saw that inflation was declining more slowly than was necessary.

In his defence, Bailey had no point of reference since he was dealing with unprecedented events and an MPC whose independent members often gave the impression that they were taking part in an academic exercise rather than creating monetary policy to balance the country’s growth and output against price stability.

One leading commentator believes that Bailey is too conservative in his outlook, he “constantly gives the impression that he is dithering and is not decisive enough in his thought processes.”

Rachel Reeves is unable to stay out of the headlines. In a speech she delivered yesterday, she refused to rule out a rise in the level of capital gains tax in her Autumn Budget, which is now just two months away,

During a visit to the US, Ms Reeves said it was important to “strike the right balance” when deciding on tax policies. The chancellor has previously warned the government that it will have to raise taxes to bolster the public finances but has not specified which ones yet. This is despite an undertaking that taxes would not rise under Labour rule.

The pound has endured a tumultuous week since the decision to cut interest rates. Having initially fallen as the decision was announced, Sterling then saw something of a rally as it became clear that the Federal Reserve would face pressure to cut rates itself in the wake of lower job creation in July.

Then, as the dollar regained its poise, it fell again versus the Greenback to a low yesterday of 1.2672 and closed at 1,2691.

Versus the Euro, it has fallen ever since rates were cut. It opened last Thursday at 1.1875 and closed last evening at 1.1609.

Regional Fed President Austen Goolsbee was the “first cab off the rank” in both defending the FOMC’s decision to leave rates unchanged at its meeting last week and confirming to the market that the Fed has the tools to deal with any “situation” that evolves in the coming weeks.

Although the dollar has had a volatile time against most G7 currencies over the past few days as asset markets have reacted to the July employment report, the Fed is still looking at the big picture.

The economy is still forging ahead, inflation is falling but slowly and wage increases are still above the level of prices.

The 107k new jobs created in July were lower than has been seen in some considerable time, Jerome Powell has spoken several times of the fact that the FOMC considered a far wider “circle of events” when considering monetary policy to fulfil its dual mandate to promote job creation while anchoring inflation at, or very close to, 2%.

Goolsbee vowed in an interview yesterday that the Fed would “fix” any weakness in the economy.

Asked whether weakening in the labour market and manufacturing sector could prompt a response from the Fed, Goolsbee did not commit to a specific course of action but said it does not make sense to keep a “restrictive” policy stance if the economy is weakening.

No FOMC has ever cut interest rates while the economy is exhibiting GDP numbers like what has been seen in the first two quarters of 2024.

However, Since the FOMC will have a very good idea of the Q3 data when it next meets, a reaction should be expected.

Goolsbee also refused to rule out an emergency cut, although it is felt that the increased volatility and weakness in asset markets are more reactive than structural.

The dollar index regained a little composure yesterday, following two days of significant falls. It climbed to a high of 103.23 and closed at 102.90. In early Asian trade this morning, it rallied above yesterday’s closing rate and is currently (0500 BST) trading at 103.30.

The market will be keenly observing tomorrow’s release of weekly jobless claims data to see if it breaches the 250k level which is considered a “watershed”.

Although the Eurozone economy has not completely collapsed into recession and continues to “bump along the bottom” as purchasing managers’ indexes show mediocre signs of expansion, the mood amongst consumers, who in other G7 economies are the growth engine of the economy, is still reactive.

“Joe Public” is still concerned that his energy bill will rise again as summer turns to Autumn and the Russian invasion of Ukraine shows no sign of ending, while the situation in the Middle East could explode into an all-out war at any time.

Retail sales unexpectedly fell in June in the eurozone as a consumption-led recovery continued to prove elusive.

Total retail activity fell by 0.3% in May, data from Eurostat revealed, confounding estimates from analysts who predicted a 0.1% increase.

However, there was better news for the historical data, with April’s retail sales figure being revised upwards from 0.3% to 0.5%.

If one sets aside the ECB’s unnecessary hawkishness over inflation, market conditions show that at least two further rate cuts should be agreed before the end of the year.

Data for construction activity continues to disappoint. Building is a sector which feeds into so many other areas of the economy. This means that it is a useful “bellwether” for activity in general.

France saw its most dramatic fall in construction activity since January, while German firms continue to struggle. The construction industry in the eurozone is suffering from weak demand that has led to a raft of job losses and cost-cutting measures.

The Construction PMI Total Activity Index, a seasonally adjusted indicator that tracks monthly changes in the construction sector, came in at 41.4 last month. This was well below the cut-off point between contraction and expansion, which is set at 50.

The weakness in construction is not limited to housebuilding. Commercial activity also worsened, as the downturn in the civil engineering sector softened compared to June, mainly due to France.

Robert Holzmann, the ultra-hawkish Austrian Central Bank Head, finishes his stint as Governor next year. He is set to be replaced by Economy Minister Martin Kocher, who will struggle to match Holzmann’s “hawkish tendencies.”

Yesterday, the Euro lost ground following two days of significant rises. It fell to a low of 1.0903 and closed at 1.0931 as the dollar found support at lower levels.

There is little interest in driving the single currency through major resistance at 1.10 particularly since the threat of an emergency rate cut by the Fed has receded and both the Fed and ECB are likely to loosen monetary policy next month.

Have a great day!