9 January 2025: Reeves eyes spending cuts as the cost of borrowing increases

The market’s reaction to the measures introduced by the Chancellor in the Autumn Statement had been critical, but that has now changed to major concerns about how the country will achieve growth with businesses coming under pressure to pay higher rates of national Insurance from April which is likely to curtain employment severely.

Investors have decided that the country needs to pay more to borrow the vast sums that Rachel Reeves has sanctioned to invest in the projects that are designed to put the country’s services and infrastructure on a more solid footing.

Following on from the fall in the price of thirty-year bonds on Monday, pushing their yield to their highest in twenty-five years, the price of ten-year paper slumped yesterday, seeing its yield at its highest since 2008.

Reeves is facing her own “Liz Truss moment”, in which she has confirmed to her in no uncertain terms that the market will dictate what is sound fiscal policy and if it doesn’t like what it is seeing, it will react negatively.

Sterling tumbled as well, shedding more than 1.2% against the U.S. dollar to hit its lowest since April at 1.2322, in a move that had no obvious trigger from economic data.

British government bond yields have climbed steadily since September, reflecting reduced expectations of Bank of England rate cuts, extra borrowing in the new government’s Oct. 30 budget and higher U.S. Treasury yields as President-elect Donald Trump is expected to pursue a loose fiscal policy and raise tariffs.

Having left recklessly little headroom in the Budget, higher debt repayments mean the Chancellor is uncomfortably close to breaking her fiscal rules, set on October 30.

She has two options, either slash public spending or kill any growth by reneging on her promise not to hike taxes again.

Increased borrowing costs also mean higher interest rates for longer, inflicting yet more pain on families with mortgages and businesses with loans.

Her promise to make sure that the country has a solid base fiscally on which to base her “drive for growth” is in tatters.

Economic output has been falling since the election, with businesses initially concerned that the new Government was “biting off more than it could chew”, using the Tory Government of the previous fourteen years as an excuse for all that was wrong, including the apparent black hole ion the nations finances, something that the previous Chancellor constantly disputes.

Now, Reeves has a black hole solely of her own making. The increased interest rate costs could be as high as ten billion pounds a year. This will either severely curtail investment in services like cutting NHS waiting lists and care for the elderly or another raid on taxes, this time on individuals.

Having fallen to a low of 1.2322 yesterday, the pound eventually closed at 1.2362.

The minutes of the latest FOMC meeting were published last evening.

Having been afforded the luxury of being able to cut interest rates according to its timetable, as inflation tumbled and growth remained robust, Jerome Powell and his colleagues appear to have reached a crossroads at which they are seeing that cutting rates has slowed deflation to such a degree that it now appears that they will have slow, if not halt, rate cuts altogether if they are to reach their self-imposed 2% target for inflation.

At the FOMC meeting, which took place in the aftermath of Donald Trump’s stunning election triumph, its members were already voicing concerns that the effect of Trump’s policies would see inflation rise again, while also marginally reducing GDP.

Without calling out Trump by name, the meeting summary featured at least four mentions of the effect that changes in immigration and trade policy could have on the U.S. economy.

Since Trump’s November election victory, he has signalled plans for aggressive, punitive tariffs on China, Mexico, and Canada as well as the other U.S. trading partners. In addition, he intends to pursue more deregulation and mass deportations.

The latest is significant tariffs on Denmark for its refusal to even countenance the sale of Greenland to the U.S.

The world’s largest island is considered crucial to Trump’s plans for defence, as well as being rich in natural resources. Along with control of the Panama Canal, Trump is not being coy in any way about his plans to increase American influence globally.

Having hit upon the idea of tariffs on his nation’s import of finished goods, he originally planned to use them as a “blunt instrument” with which to beat certain nations, but more recently he has alluded to more “targeted” measures.

Almost the entire FOMC judged that upside risks to the inflation outlook had increased,” the minutes said. “As reasons for this judgment, participants cited recent stronger-than-expected readings on inflation and the likely effects of potential changes in trade and immigration policy.”

They also reduced their outlook for expected cuts in 2025 to two from four in the previous estimate at September’s meeting, assuming twenty-five-point increments.

The Fed cut 100 points off the funds rate since September, and current market pricing is indicating just one or two more moves lower this year.

According to the CME Group’s Fed Watch gauge, traders are assigning a nearly 100% chance that the FOMC will stand pat at its Jan. 28-29 meeting.

The dollar rallied off the back of the minutes as traders believed the divergence between U.S. and Eurozone monetary policy would continue while other G7 members remain sidelined. The dollar index rallied to a high of 109.37 and closed at 109.00.

Eurozone inflation hit 2.4 per cent in December, the highest since July, but experts expect the European Central Bank to continue cutting rates slowly amid the region’s weak economic outlook.

In the recent past, even before the end of the third quarter of 2024, this would have been a radical idea, but the Bank’s Governing Council has gradually come around to both the issue of growth and economic output across the entire Eurozone as well as there being no need for inflation to be reduced to its 2% target before the end of 2025.

There are still hawks, like Austrian Central Bank Governor, Robert Holzmann, who believe that inflation may aggressively return, but facing the possibility of stagflation, in which prices continue to rise even as growth falls, the majority see that loosening monetary policy, even at a moderate pace, is preferable.

The market still sees the ECB cutting rates during the first half of 2025, but maybe not at every meeting. Following the flurry of rate cuts that characterized the third and fourth quarters of last year, January is expected to be a month of contemplation for G7 Central Banks.

The EU’s Lisbon Strategy for Growth and Jobs should be kept even during the challenging times, EU leaders agreed. But concrete discussions over how the European Commission’s flagship reform agenda should be adapted to the crisis were postponed to a later date, a report from France suggests.

Mario Draghi’s twelve-year-old “whatever it takes” spirit is now insufficient to stimulate investment, growth, and confidence in the Eurozone.

The economic imbalance between the North and South and geopolitical divisions between East and West are tearing the Eurozone apart. Draghi’s recent proposals to end structural barriers to economic growth need to be discussed and agreed upon before the clock towards recession counts down to zero.

It will be a lot easier to avoid a recession than get out of one, according to several economists.

The European Commission needs to take more of a lead in driving the economy forward. The ECB has fulfilled a dual role, as both policy instigator and deliverer of policy, as both the Commission and Parliament have sat on their hands.

The European Parliament appears to be more intent on social change than wealth creation, while Ursula von der Leyen hides behind Christine Lagarde.

With Trump’s tariff threats looming, China’s export machine is revving up again, and Draghi’s successor Christine Lagarde now faces a life-and-death moment. The leadership vacuum in France and Germany requires institutions to step up.

Since June, the ECB has cut interest rates four times, acknowledging the urgency of the situation to some extent. However, at the same time, Europe’s “heavy artillery” is still firmly locked in the vault, and its rhetoric remains cautious.

The Euro fell to a low of 1.0273 yesterday as the Fed signalled a pause in rate cuts. It closed at 1.0316 as a few bottom feeders took advantage of short-term bargains.

Have a great day!