It has been a busy week in the UK, not least with the announcement of a general election that no-one seems to think the incumbent Conservative party will be able to win
The Prime Minister Rishi Sunak announced the election will take place on 4th July, with Parliament to be dissolved next week. The Prime Minister appears to be hoping that recent better economic news, including a return to economic growth and easing inflation will provide a platform to close the huge gap to Labour in the opinion polls, which has failed to budge despite two recent fiscal events that have seen tax cuts. Rishi Sunak warned of the “dangers” of switching to Labour, while Labour leader Kier Starmer called for “change”, saying “together we can stop the chaos.”
The election news was a surprise to many, including some Conservative MPs and ministers, given it did not have to be held until 28th January 2025 and the consensus was around a late autumn election to allow the economy to recover further. The Financial Times reported Chancellor Jeremy Hunt and Prime Minister Sunak had concluded there was no further scope for tax cuts later this year and there was little chance of interest rate cuts having a positive impact on voters’ moods.
Polling averages put the Labour Party on 44% and the Conservatives on 23%. The polls have barely shifted since the September 2022 mini budget debacle under Sunak’s predecessor Liz Truss. Labour’s lead is as large now as it was in 1997, when Tony Blair defeated John Major – Rishi Sunak now has six weeks to turn this around.
The pace of UK inflation saw a substantial decrease in April, with CPI easing to 2.3% year on year from 3.2% in March. This means UK inflation is now lower than the US and the eurozone, for the first time since March 2022. The substantial decrease in the pace of inflation was thanks to a drop in the energy price cap, which fell by 12% in April. While the CPI data is now at the lowest level since the summer of 2021 and closing in on the Bank of England’s 2% target, it was still higher than expected, and the services CPI data remained sticky at 5.9% year on year, barely budging from the 6.0% figure of March and well ahead of the 5.5% forecast by the Bank of England.
Prime Minister Rishi Sunak hailed the 2.3% CPI print as evidence that price growth was “back to normal”, but the Bank of England’s Monetary Policy Committee are unlikely to agree. With core inflation (which excludes food and energy) still at 3.9%, services inflation still uncomfortably high and wages still growing strongly, it would appear the Bank of England is now very unlikely to start easing monetary policy when they meet in June, preferring to gain more confidence that the sticky elements of inflation are truly under control. Market expectations for a June rate cut evaporated on the data release, with the first 25 basis point cut now not fully priced until November. Until the CPI data was published, markets were anticipating a 25 basis point cut in August.
The International Monetary Fund IMF) published a ‘health check’ on the UK economy, warning of a need to close a near £30bn gap in the public finances and arguing that there is no capacity for new rounds of tax cuts. Before the election was announced, the expectation was that we would see another fiscal event later this year.
But, in reality, the scope for further tax or national insurance cuts was extremely limited and would have only been possible based on optimistic growth projections at the latter stages of the forecast horizon. The government’s finances will likely be further impacted by the significant costs of compensation for maladministration in the NHS and Post Office over recent decades. Higher borrowing costs as a result of interest rates staying higher for longer will also have a negative impact. The IMF noted that in the absence of a major boost to potential growth, stabilising debt in the medium term “will probably involve some tough choices”. While the fiscal outlook was challenging, the IMF was more positive on the economic outlook, upgrading their growth forecast for the UK economy to 0.7% in 2024 against 0.5% made in their world economic outlook last month. Inflation is expected to return “durably” to the 2% target in 2025, paving the way for potentially two or three 25 basis point interest rate cuts in 2024 and a further 100bps of cuts in 2025.
In the world of central banks there remains a considerable contrast between the European Central Bank (ECB) and US Federal Reserve (Fed), with the ECB making very clear a June rate cut is likely while the Fed speakers continue to highlight the need for patience and being guided by the economic data. Fed Vice Chair, Philip Jefferson, described April’s CPI data as “encouraging” with Vice Chair for Supervision, Michael Barr, saying “I think that we are in a good position to hold steady and closely watch how conditions evolve; we need to sit tight where we are for longer than we previously thought”. Mary Daly of the San Francisco Federal Reserve said there is “no urgency to adjust rates” while Loretta Mester of the Cleveland Fed said “it’s too soon to tell what path inflation is on”.
Fed Governor, Christopher Waller, said nascent signs of a slowdown in inflation and economic growth means the central bank can “probably rule out interest rate rises” and he was “happy to see a reversal,” in April, of the acceleration in CPI during the first quarter of the year. However, Waller warned that “in the absence of a significant weakening in the labour market, I need to see several more months of good inflation data before I would be comfortable supporting an easing in the stance of monetary policy”. Waller reiterated the patience narrative, saying “we’re not seeing anything right now that looks like staying here for three or four months is going to cause the economy to go off a cliff”. The minutes of the Fed meeting at the start of the month showed officials to be coalescing around the view that rates needed to be higher for longer, with many questioning whether policy was actually restrictive enough.
There was no such caution from the European Central Bank, where bank President Christine Lagarde said there is a “strong likelihood” of a move in June given she is “really confident that we have inflation under control”. Lagarde said that the ECB inflation forecasts for 2025 and 2026 “is really getting very, very close to target, if not at target, so I am confident that we’ve gone to a control phase”. Her colleague Joachim Nagel of the German Bundesbank expressed caution over what will follow the first rate cut however, saying “We should not cut rates hastily and jeopardise what we have achieved. Even if rates are lowered for the first time in June, that does not mean we will cut rates further….we are not on auto-pilot.”
There will be no update from me next week. I’m spending the half-term break accompanying my eldest son and his teammates for an Under 13’s football tour to Germany. I am told the bus journey from our start point in Somerset to our destination near Nuremburg will take the best part of 17 hours! This sounds very much like a holiday that will require another holiday to get over it!
Enjoy the bank holiday weekend.
Kind regards,
Anthony.
Source: Columbia Threadneedle Investments as at 24.05.24
