Back to 1976

What a first full week of the new year. The speed and extent of the moves in the financial markets may have drawn comparisons with the fallout from Liz Truss’s mini-budget in October 2022 but according to former BoE (Bank of England) interest rate setter Martin Weale and others, a more apt comparison would be to the 1976 crisis that forced the then Labour government of Jim Callaghan to send Chancellor Denis Healey to Washington on 28 September 1976 for an emergency IMF (International Monetary Fund) bailout.

Weale, now a professor of economics at King’s College, London said “We haven’t really seen the toxic combination of a sharp fall in sterling and long-term interest rates going up since 1976. That led to the IMF bailout. So far, we are not in that position, but it must be one of the chancellor’s nightmares. Policy over the last 20 years has been to let the debt rise when things go wrong and not offset that when the sun is shining. Perhaps it’s surprising that markets may only now be getting concerned about that”.

Nigel Green, chief executive of DeVere, one of the world’s largest independent advisory businesses, called this week, a “brutal throwback to 1976”.

Currency Exchange Rates Update

The Pound fell to its lowest level against the Euro since last November and its lowest level against the US Dollar since November 2023.

The Pound has now lost over 2% against the Euro and over 3% against the US Dollar since Christmas Day.

What’s in the news?

Bill Clinton’s chief strategist James Carville famously said “I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would want to come back as the bond market. You can intimidate everybody.”

The bond markets can break Governments, if it chooses, as Governments are dependent on them to fund spending. If investors stop buying government bonds, the modern financial system falls over. The bond markets discipline excessive government spending by demanding higher yields to buy their bonds.

Bond investors are big global financial institutions. When they buy UK government bonds, known as gilts, they want to be certain their money is safe. Under this government, they're not certain. So, they’re demanding a higher yield (a bigger interest rate return) to offset the risk.

Before the general election in July last year, Chancellor Rachel Reeves launched a huge a charm offensive, pledging stability and growth. The bond markets took Reeves at her word. After the July election, yields on 10-year gilts slid to 3.75%. Last Thursday, they hit 4.9%, their highest level since 2008. Greece is only currently paying 3.37%. The bond markets currently trust the Greeks a lot more than they currently trust the UK. UK gilt yields has seen the most significant increase among the G7.

These higher gilt yields will add an estimated ￡10billion to UK borrowing costs, blowing a hole in Reeves' fiscal plans and forcing her to cut spending or raise taxes again to make her sums add up.

UK

Not so good news

Official forecasts suggest the UK government’s fiscal plans will contribute to higher inflation, forcing the BoE to slow the pace of interest rate cuts. All this while the growth outlook remains poor.

Deutsche Bank has warned Rachel Reeves may be forced to raise taxes again after launching ￡40bn worth of tax hikes at the 30 October Budget last year.

In a note to investors, the investment bank warned that growth was likely to slide below the OBR (Office for Budget Responsibility) projections in October after the economy flatlined toward the end of last year. The UK economy shrank 0.1% in October for the second consecutive month.

The government has said economic growth is its “number one mission” since taking office in July 2024.

Economists at Goldman Sachs have warned Rachel Reeves’s surging borrowing costs will drive up interest rates on mortgages and business loans, hitting the economy and further undermining the public finances. James Moberly at GS is forecasting the UK economy will now grow by only 0.9% in 2025, less than half the 2% predicted by the OBR last October with higher interest rates in financial markets worsening the situation.

Sarah Coles, head of personal finance at Hargreaves Lansdown said, “The rise in gilt yields always raises the spectre of rising fixed mortgage rates, because they’re very responsive to changes in interest rate expectations”.

A survey from the BoE suggests inflationary pressures are likely to persist this year as firms prepare to raise prices, reduce pay and cut staff to combat the effects of Rachel Reeves’ tax-raiding Budget.

A survey by accountants KMPG and the REC (Recruitment and Employment Confederation) shows recruitment falling to a 16-month low after last year’s Budget.

The S&P construction PMI (Purchasing Managers’ Index) shows construction activity in the UK economy fell to a six-month low in December with momentum slowing across the sector whilst data from the S&P Global UK Services PMI showed UK firms shedding jobs at the fastest rate in three years amid the payroll tax rises introduced in October’s budget. It’s the steepest decline in service sector jobs since January 2021.

Sarah Breeden, the BoE’s deputy governor has admitted net zero policies are sharply driving up energy costs. Breeden said households and businesses were paying more for energy because of so-called carbon permits, which require power plants to pay for each tonne of carbon dioxide they emit. These permits accounted for nearly half the cost of fuel bought by gas-fired power plants last year, a cost passed on to consumers.

NESO (The National Energy System Operator) reported that the UK came “within a whisker of blackouts” last Wednesday after plunging temperatures and low wind power generation left electricity grid operators struggling to keep the lights on. Last Wednesday afternoon, the spare electricity capacity on the national grid had fallen to just 580 megawatts, a level sufficiently low that even an outage at a “relatively small” power station “would have caused an actual shortage and triggered blackouts” according to experts.

British Gas owner Centrica said Britain’s gas reserves have dwindled to a “concerning” low with just a week of supply left as freezing temperatures and low winds grip the country. The UK’s storage sites are about half full, 26% lower than this time last year.

Thousands of civil servants have voted to strike “indefinitely” from this month following an order to return to the office for three days a week.

The latest YouGov poll has put Labour’s net approval at -47%. Labour finished 2024 with a historic low net approval of -45% after a steady decline in the opinion polls since its election win last July. Even four out of 10 of those who voted for Sir Keir’s party said they disapproved of the Government’s record.

USA

The Dow Jones index fell by nearly 700 points on Friday after a stronger than expected US jobs report and a worsening inflation outlook. US payrolls grew by 256,000 in December. Economists polled by Dow Jones expected an increase of 155,000. The US unemployment rate was projected to remain at 4.2% but fell to 4.1%.

The yield on the benchmark US 10-year Treasury note spiked to its highest level since late 2023 after the jobs report.

Scott Wren, Wells Fargo Investment Institute senior global market strategist said, “Good news for the economy but not for the markets, at least for now. However, this unexpected gain relative to the consensus projection does not change our view that the labor market is likely to decelerate further in coming quarters.”

The Federal Reserve’s minutes from their December meeting showed that officials were worried about inflation and the impact of President-elect Donald Trump’s policies and indicated that they would be moving more slowly on interest rate cuts in 2025.

Outstanding US consumer debt fell in November by the most in over a year as credit-card balances plunged by $7.5 billion.

Donald Trump has been given an unconditional discharge over his “hush money” conviction, escaping any sanction in the historic criminal case days before he re-enters the White House.

Deadly fires in and around Los Angeles continue to force residents from their homes as firefighters struggle to bring several blazes under control. Almost 180,000 people have been told to evacuate. A leaked memo reveals Democrat LA Mayor Karen Bass demanded her fire department cut an extra $49M of funding for fighting fires to subsidize homelessness and DEI (Diversity, Equity and Inclusion) programs last year.

The EU

The eurozone annual inflation rate rose for a third straight month in December.

German industrial orders data unexpectedly fell by 5.4% in November. German retail sales also contracted in November, adding to concerns about the health of the Eurozone’s largest economy.

Fran?ois Villeroy de Galhau, the Bank of France Governor said the French government, presiding over the largest deficit in the euro area this year, must be as ambitious as possible with budget cuts to tackle the “chronic sickness” of the country’s public finances and restore economic confidence after months of political upheaval. Current PM, Fran?ois Bayrou is France’s fourth PM since the start of 2024 and heads a minority government.

Others

China’s consumer inflation rate fell for a fourth straight month.

Justin Trudeau resigned as prime minister of Canada after nine years in office. He will remain as prime minister until his Liberal Party select a new leader. The Canadian parliament is suspended until 24 March while that process takes place. Canada must hold an election by October and is very likely to install a new conservative government headed by Conservative Party leader Pierre Poilievre.

Stranger than fiction

Train services were cancelled last weekend after the trade union Aslef told drivers, recently given a 15% pay rise to just under ￡70,000 a year by Labour, not to walk on snow.

As a result, Avanti West Coast services between Liverpool and London did not run for several hours last Sunday morning.

Quote

German economist and philosopher Karl Marx “History repeats itself, first as tragedy, second as farce”.