I’m afraid there is no money

Former Treasury Minister Liam Bryne left a now infamous note for his successor when Labour left government in May 2010. It said, ’Dear Chief Secretary, I’m afraid there is no money. Kind Regards – and good luck! Liam.’

Given the recent success in local by-elections and with the Labour party 20% ahead in the polls, Sir Kier Starmer must be feeling confident with a general election looming in 2024. However, whoever wins is going to face the same challenge. The era of cheap money is over, and no longer will politicians be able to promise UK households the moon.

The world has faced a string of major challenges from the Covid-19 pandemic, the war in Ukraine, an energy crisis, and now conflict in the Middle East. This has required higher borrowing as governments have sought to provide support for businesses and households. As a result, the ratio of government debt to GDP of the leading G7 economies, which includes the UK, has stuck stubbornly at or near record levels. What happened to Liz Truss’s ill-fated and short-lived government now awaits other governments that resort to greater borrowing. When she went ‘all in’ on a growth agenda and tried to borrow more to finance tax cuts, bond markets reacted adversely.

Chancellor Jeremy Hunt has restored a measure of financial discipline, but has had to unleash stimulus measures to help claw back some of Labour’s lead in the polls. Meanwhile, shadow Chancellor Rachel Reeves has so far proposed tax rises for private schools and non-domiciles, but this could be a ‘drop in the ocean’ compared with demands for spending by Labour MPs. Labour would also have to appease Union demands for further pay rises. Would a Labour government turn to windfall taxes on some UK sectors to help fill the hole?

The end of the era of cheap money is also hitting local authorities with warnings that more councils could go bust, after Birmingham declared itself effectively bankrupt, requiring government intervention. Last week, Nottingham City Council also issued a section 114 notice temporarily halting most new spending and declared itself effectively bankrupt.

An ageing UK population and the pressures this places on the NHS and social care, as well as the need for higher defence spending will not give the next Chancellor, whoever it is, much ‘wriggle room.’

What have we been watching?

Markets ended November in a slightly more optimistic mood on hopes of peak US interest rates, despite ongoing challenges within the Chinese economy from its heavily indebted property sector. However, Sterling moved up above $1.26, creating a headwind for UK exporters and overseas earners as Bank of England Governor Andrew Bailey once again warned that interest rates will not be cut in the ‘foreseeable future.’  The US Dollar also weakened as two members of the Federal Reserve made the case for holding interest rates steady. US Treasuries had their best month in November since the 1980’s with the 10-year yield having dropped back from almost 4.9% at the end of October to under 4.3%.

The truce between Hamas and Israel has broken down and the IDF has moved into all areas of Gaza. Tensions in the Middle East remain elevated and missiles were fired from rebel territory in Yemen towards an Israeli-affiliated tanker and a US destroyer in the Gulf of Aden. Meanwhile, the war of attrition in Ukraine continues and Turkey’s soaring exports of war-linked goods to Russia have led the US to send an envoy to Ankara.

There is no end in sight to the ongoing trade spat between the US and China. The US has unveiled rules aimed at keeping Chinese components out of electric cars sold in the country. 

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Eurozone inflation fell more than expected to 2.4% in November from 2.9% in October. The data raised hopes that the European Central Bank might consider cutting interest rates by spring 2024.

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US economic activity has slowed while the outlook for the next six-to-twelve months has diminished according to the Federal Reserve’s Beige Book.  The Federal Reserve’s (Fed) preferred inflation measure, the PCE deflator dipped further in October to 3%, while the core measure was in line with expectations at 3.5%. Despite Fed Chair Jerome Powell working hard in his latest speech to moderate some expectations that an interest rate cut was just months away, investors instead focused on his comment that the Fed is ‘well into restrictive territory.’

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China’s factory activity contracted in November for the second month-in-a-row with the manufacturing PMI dipping from 49.7 to 49.4. China’s troubled property sector remains in focus with a court ruling on Evergrande’s restructuring plan postponed until the end of January to give it longer to agree a deal with creditors.

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Brent oil drifted to $78 despite OPEC+ agreeing to a voluntary cut of an extra 1 million barrels a day and Saudi Arabia extending its voluntary cut of a similar amount. This appears more ambiguous and less significant than market expectations.

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Finally, if you thought the UK’s finances were tight spare a thought for New Zealand. The new conservative government has said it plans to scrap the country’s world-leading smoking ban to fund tax cuts. Modelling had suggested the Smokefree laws could save up to 5,000 lives a year and would also save the health service £630m over twenty years. The government must be hard-pressed for funds – a case of robbing Peter to pay Paul?

Read Last Week’s Alpha Bites – China Crisis

 

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.