Economy

“Transitory” inflation is back, baby, almost a year after Federal Reserve chair Jay Powell supposedly buried the word for good.Readers will remember that Powell was fond of the phrase for much of 2021, when rising energy costs, supply chain bottlenecks and the shift in consumption from services to goods really began to push up prices. It was only in November, once philosopher king US senator Pat Toomey had pointed out how, in reality, “everything is transitory — life is transitory” that Powell said he would try to “explain more clearly” what he meant. Inflation — at 6.2 per cent at the time — was officially transitory no more.History became legend, legend became myth, and for most of the year the word passed out of all use. Until, that is, October’s surprisingly chill consumer price figures landed early on Thursday. Here’s JPMorgan opining on the data as if the past 12 months (and boss Jamie Dimon’s hawkish April letter to shareholders) were all just a bad dream (emphasis our own):The October consumer price index (CPI) was softer than expectations. The headline index increased 0.4%, with energy prices increasing 1.8%, food prices rising 0.6%, and a 0.3% gain for the core (0.272% to three decimals). These monthly figures were not particularly soft by pre-pandemic standards, and year-ago inflation rates remained strong in October (headline at 7.7% oya, core at 6.3% oya) even if they have cooled somewhat relative to recent earlier figures. But, overall, the October report supports the idea that we are moving past the firmest period for inflation and that a decent amount of the inflation we have seen over the past year will prove to be temporary or transitory in nature.That’s a bold call. Labour markets are as tight as ever, money is still pretty cheap and energy prices remain sky high. Even so, economist Brad DeLong writes that Team Transitory would be looking “pretty good right now” were it not for Russia’s invasion of Ukraine:The arguments against the way macro economic policy has been conducted since January 2021 hinge on claims policymakers should’ve expected, or at least acted as though they expected, Vladimir Putin.Of course, saying that policy was reasonably conducted in 2021 does not help us right now. But it is important to register that we have a Putin inflation problem, not a miss managed-recovery inflation problem.Putin or no Putin, perhaps 2021 Powell was right all along. November’s CPI will provide more clues.   More

Federal Reserve officials welcomed Thursday’s news that inflation might have peaked, but cautioned against getting too excited by the data.
“It’s far from a victory,” San Francisco Fed President Mary Daly said.
Dallas Fed President Lorie Logan called the CPI report “a welcome relief” but noted more rate increases probably are coming, albeit at a slower pace.

Prices of fruit and vegetables are on display in a store in Brooklyn, New York City, March 29, 2022.
Andrew Kelly | Reuters

Federal Reserve officials welcomed Thursday’s news showing that inflation rose less than expected last month, and they noted that interest rate increases could slow ahead.
But they also cautioned against getting too excited by the data, saying that prices are still far too high.

“One month of data does not a victory make, and I think it’s really important to be thoughtful that this is just one piece of positive information, but we’re looking at a whole set of information,” San Francisco Fed President Mary Daly said during a question-and-answer session with the European Economics and Financial Centre.
Daly and other Fed officials were speaking after the Bureau of Labor Statistics reported that the consumer price index rose 0.4% in October, below the 0.6% Dow Jones estimate. The data sent a possible signal that while inflation is still running high, price increases may have leveled off and could soon head lower.
Markets staged a massive rally following the report, with the Dow Jones Industrial Average soaring more than 1,000 points. The policy-sensitive 2-year Treasury note yield tumbled 30 basis points, or 0.3 percentage point, to 4.33%.
While Daly said the report was “indeed good news,” she noted that inflation running at a 7.7% annual rate is still far too high and well off the central bank’s 2% goal.
“It’s better than over 8 [percent] but it’s not close enough to 2 in any way for me to be comfortable,” she said. “So it’s far from a victory.”

Likewise, Cleveland Fed President Loretta Mester said Thursday’s report “suggests some easing in overall and core inflation,” though she noted the trend is still “unacceptably high.”
Kansas City Fed President Esther George noted that even with the lower monthly gain, inflation is still “uncomfortably close” to the 41-year annual high hit in the summer.
“With inflation still elevated and likely to persist, monetary policy clearly has more work to do,” she said.
However, she advocated a more “deliberate” approach going forward, noting that “now is a particularly important time to avoid unduly contributing to financial market volatility.”
Both Mester and George are voting members this year on the rate-setting Federal Open Market Committee.

Market pricing in lower hikes

The Fed has raised its benchmark interest rate six times this year for a total of 3.75 percentage points. That has included a string of four straight 0.75 percentage point hikes, the most aggressive policy tightening since the central bank moved to using the overnight rate as its principal policy tool in 1990.
Market pricing immediately reacted to the CPI news, shifting strongly to the likelihood of a 0.5 percentage point increase in December, according to CME Group data calling for an 85.4% probability of a half-point hike.
“Despite the moves we have made so far, given that inflation has consistently proven to be more persistent than expected and there are significant costs of continued high inflation, I currently view the larger risks as coming from tightening too little,” Mester said.
Other officials also were cautious.
Dallas Fed President Lorie Logan called the CPI report “a welcome relief” but noted more rate increases probably are coming, though at a slower pace. “I believe it may soon be appropriate to slow the pace of rate increases so we can better assess how financial and economic conditions are evolving,” she said.

No rate cuts in sight

Like Daly, Logan said the public should not interpret a slower pace of rate hikes to mean an easing in policy.
In particular, Daly said rates are likely to stay higher for longer and she does not anticipate a rate cut that market pricing indicates could come as soon as September 2023.
Earlier in the day, Philadelphia Fed President Patrick Harker indicated a slower pace is likely but noted the increases still will be significant.
Historically, the U.S. central bank has preferred to hike in quarter-point increments, but the rapid surge of inflation and a slow-footed response from policymakers when prices began surging early in 2021 made the more aggressive pace necessary.
“In the upcoming months, in light of the cumulative tightening we have achieved, I expect we will slow the pace of our rate hikes as we approach a sufficiently restrictive stance. But I want to be clear: A rate hike of 50 basis points would still be significant,” Harker said.
He added that he expects policy to “hold at a restrictive rate” while the Fed evaluates the impact the moves are having on the economy.

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The consumer price index increased 0.4% for the month and 7.7% from a year ago, both lower than estimates.
Excluding volatile food and energy costs, so-called core CPI increased 0.3% for the month and 6.3% on an annual basis, also lower than expectations.
Prices declined for medical care services, used vehicles and apparel. Shelter costs posted their highest monthly gain since 1990.
Markets soared on the report and Treasury yields tumbled.

The consumer price index rose less than expected in October, an indication that while inflation is still a threat to the U.S. economy, pressures could be starting to cool.
The index, a broad-based measure of goods and services costs, increased 0.4% for the month and 7.7% from a year ago, according to a Bureau of Labor Statistics release Thursday. Respective estimates from Dow Jones were for rises of 0.6% and 7.9%.

Excluding volatile food and energy costs, so-called core CPI increased 0.3% for the month and 6.3% on an annual basis, compared with respective estimates of 0.5% and 6.5%.

A 2.4% decline in used vehicle prices helped bring down the inflation figures. Apparel prices fell 0.7% and medical care services were lower by 0.6%.
“The report overstates the case that inflation is coming in, but it makes a case inflation is coming in,” said Mark Zandi, chief economist at Moody’s Analytics. “It’s pretty clear that inflation has definitely peaked and is rolling over. All the trend lines suggest that it will continue to moderate going forward, assuming that nothing goes off the rails.”
Markets reacted sharply to the report, with the Dow Jones Industrial Average up more than 1,000 points. Treasury yields fell sharply, with the policy-sensitive 2-year note tumbling 0.3 percentage point to 4.33%.
“The trend in inflation is a welcome development, so that’s great news in terms of the report,” said Michael Arone, chief investment strategist at State Street Global Advisors. “However, investors are still gullible and they are still impatiently waiting for the Powell pivot, and I’m not sure it’s coming anytime soon. So I think this morning’s enthusiasm is a bit of an overreaction.”

The “Powell pivot” comment refers to market expectations that Federal Reserve Chairman Jerome Powell and his central bank colleagues soon will slow or stop the aggressive pace of interest rate increases they’ve been deploying to try to bring down inflation.
Even with the slowdown in the inflation rate, it still remains well above the Fed’s 2% target, and several areas of the report show that the cost of living remains high.
“One month of data does not a victory make, and I think it’s really important to be thoughtful that this is just one piece of positive information, but we’re looking at a whole set of information,” San Francisco Fed President Mary Daly said in response to the CPI data.
“We have to be resolute to bring inflation down to 2% on average,” she added in a Q&A with the European Economics & Financial Centre. “That’s our goal, that’s what Americans depend on, and that’s what we’re committed to doing. So we’re going to continue to adjust policy until that job is fully done.”
Shelter costs, which make up about one-third of the CPI, rose 0.8% for the month, the largest monthly gain since 1990, and up 6.9% from a year ago, their highest annual level since 1982. Also, fuel oil prices exploded 19.8% higher for the month and are up 68.5% on a 12-month basis.

The food index rose 0.6% for the month and 10.9% annually, while energy was up 1.8% and 17.6%, respectively.
Because of the rise in inflation, workers took another pay cut in October. Real average hourly earnings declined 0.1% for the month and were down 2.8% on an annual basis, according to a separate BLS release.
A separate Labor Department report Thursday showed that jobless claims rose to 225,000 last week, an increase of 7,000 from the previous week.
The latest inflation reading comes as Federal Reserve officials have been deploying a series of aggressive interest rate hikes in an effort to bring down inflation running around its highest levels since the early 1980s.
In early November, the central bank approved its fourth consecutive 0.75 percentage point increase, taking its benchmark rate to a range of 3.75%-4%, the highest level in 14 years. Markets expect the Fed to continue raising, though at a possibly slower pace ahead before the fed funds rate tops out around 5% early next year.
Traders quickly changed their expectations regarding the Fed’s next move. Futures tied to the fed funds rate indicated an 80.6% probability of a 0.5 percentage point move in December, up from 56.8% a day ago, according to CME Group data.
“One data point doesn’t make a trend. What we have to hope for is we get another downtick [in CPI] with the next report, which happens the day before the next Fed meeting,” said Randy Frederick, managing director of trading and derivatives at Charles Schwab. “Markets are poised to respond to anything remotely positive. … It’s kind of like a coiled spring more than anything else.”
Getting inflation down is critical heading into the holiday shopping season. A recent survey by Clever Real Estate found that about 1 in 3 Americans plan on cutting back spending this year due to higher prices.

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It appears that Sam Bankman-Fried has not heard of blockchain’s record-keeping capabilities. In a lengthy twitter thread on Thursday, the fallen cryptocurrency tycoon blamed the collapse of his FTX exchange on a clerical error. That looks odd.SBF tweeted that he mistakenly believed that FTX customers had plenty of liquidity earlier this week to facilitate withdrawals. He was not aware of leverage within the FTX system. He could not have got it more wrong. Panicked FTX account holders were prevented from withdrawing their assets this week. SBF insists that FTX is illiquid at the moment, but not insolvent. That is, its asset value exceeds that of liabilities. He seeks a multibillion-dollar cash infusion to bridge any cash flow gap. To some, giving FTX a lifeline at the moment might seem absurd. Never mind its highly opaque operations, severe regulatory and legal risks are mounting. But a template for taking on such a risk might exist. Shares of Coinbase, the listed crypto exchange, have dropped 80 per cent in price this year as crypto trading volumes have plummeted. But it clearly lists its client assets and liabilities and cash. Moreover, it is not explicitly or tacitly lending out client funds, which FTX seems to have done.Recall the financial crisis. JPMorgan bought Bear Stearns. Barclays took on Lehman Brothers. Mistakes were made. Private equity firm TPG invested $1bn into thrift, Washington Mutual, just months before it went belly up in 2008. Wall Street has plenty of specialist funds and strategic buyers that make swashbuckling wagers during panics.This week venture capital powerhouse Sequoia wrote down its $214mn investment in FTX to zero. The Silicon Valley titan also noted, however, that in 2021 FTX had generated $250mn in operating profit. How much of that comes from fees and commissions, versus volatile trading gain, is not clear. But the former could be the basis of a restructured FTX.During the financial crisis, distressed acquisitions occurred under a strong legal and regulatory regime that oversaw the process. Nothing that substantial exists in cryptocurrency.The immediate task is unravelling the relationships between FTX customer accounts and apparent lending to SBF’s trading operation, Alameda Research. Its foolishness probably caused this week’s run on FTX. SBF had better pull together all the records he can find. More

A growing cohort of Federal Reserve officials have thrown their support behind slowing the pace of future interest rate rises, as investors increased bets on such a move following the release of slower-than-expected inflation data on Thursday.Patrick Harker, president of the Philadelphia Fed, was the latest official to back the US central bank breaking its months-long streak of supersized increases, joining his counterparts at the Boston, Chicago and Richmond branches.“In the upcoming months, in light of the cumulative tightening we have achieved, I expect we will slow the pace of our rate hikes as we approach a sufficiently restrictive stance,” Harker said on Thursday. “But I want to be clear: a rate hike of 50 basis points would still be significant.”Lorie Logan, president of the Dallas Fed, also endorsed a shift down from 0.75 percentage point rises, which the Fed has implemented at every meeting since June, but emphasised the central bank’s commitment to stamping out inflation.“While I believe it may soon be appropriate to slow the pace of rate increases so we can better assess how financial and economic conditions are evolving, I also believe a slower pace should not be taken to represent easier policy,” she said at a Fed event on Thursday.According to CME Group, traders place the odds that the Fed will opt for a smaller move next month at 85 per cent, up from roughly 50 per cent on Wednesday.The shift in expectations — which was accompanied by a sharp rally in the S&P 500 — was propelled by fresh evidence that inflationary pressures are beginning to level off in some sectors. October’s consumer price index showed prices rising by 0.4 per cent for the month, in line with September’s increase, which translates to the smallest annual rise since January. “Core” inflation, which strips out volatile items such as food and energy, slowed even more substantially, rising just 0.3 per cent compared to the 0.6 per cent increase recorded in the previous period.While economists cautioned against reading too much into a single inflation report, they acknowledged that the figures come as welcome news for the Fed, which has begun to build the case for slowing its rate rises.“It’s definitely time to slow the pace of rate hikes,” said Alan Detmeister, an economist at UBS and a former Fed staffer. “If we see slowing inflation at this point, with those lags in monetary policy, you’re likely to see inflation slow down even more.”At the Fed’s November policy meeting last week, chair Jay Powell signalled his support for smaller rate rises, which he said could come as early as December, given the time it takes for changes to monetary policy to have an effect on economic activity and how significantly rates have risen this year.As a result, the end point of the tightening cycle would be higher than originally anticipated, Powell said, and the Fed would keep rates at a level that constrains the economy for longer.Mary Daly, president of the San Francisco Fed, said October’s slowdown in consumer price growth was “good news” but “one month does not victory make”, suggesting further tightening to come.Also on Thursday, Loretta Mester, president of the Cleveland Fed, welcomed the initial easing of inflationary pressures but cautioned that there may still be “upside risks” to the forecast.“Despite the moves we have made so far, given that inflation has consistently proven to be more persistent than expected and there are significant costs of continued high inflation, I currently view the larger risks as coming from tightening too little,” she said at an event hosted by Princeton University.On Thursday, investors revised their expectations marginally lower for the so-called terminal rate and now expect the federal funds rate to peak at 4.8 per cent, having previously predicted that it would surpass 5 per cent.Yields on US government bonds also plummeted, with the policy-sensitive two-year note trading at 4.3 per cent, down from 4.6 per cent the previous day.

Aneta Markowska, chief financial economist at Jefferies, called the latest inflation data “the best piece of news in a while”. However, she reiterated her belief that the benchmark policy rate would eventually reach 5.1 per cent, arguing that the Fed needs to see a “long string” of weaker monthly core readings “before they are comfortable pausing”.One concern is that wage increases stemming from the tight labour market may continue to push up consumer price growth in the services sector, suggesting price pressures will be difficult to fully eliminate.“There’s still a significant chance that we may see some very strong inflation on the services side in the coming months,” said Detmeister at UBS. More

The outgoing EU ambassador to the UK has claimed there is a window to resolve the corrosive post-Brexit dispute over Northern Ireland because “the mood music has changed”, leaving the two sides “not that far apart”. In an interview with the Financial Times, João Vale de Almeida said he had been “encouraged” by prime minister Rishi Sunak’s early meetings with EU leaders and that an agreement would transform relations, clearing the way for Britain to join the €95bn Horizon Europe research project. “Contact between leaders and intimacy has been lacking,” he said, reflecting on his three years as the EU’s first envoy to Britain and the bad feeling and mistrust that flowed from Brexit.“We’ve had more summits with China than we have had with the UK,” said Vale de Almeida. “There have been none. That’s not normal. These people need to share their WhatsApp numbers.”The view in Brussels is that Sunak, even though he supported Leave in the 2016 referendum, arrived in Downing Street without the Brexit baggage of Boris Johnson and will see EU relations through an economic lens.Sunak this week held positive talks with EU leaders including European Commission president Ursula von der Leyen and French president Emmanuel Macron at the COP27 summit in Egypt. “There’s a new cycle in Britain and there should be a new cycle in UK-EU relations,” the ambassador said.Vale de Almeida took up his “job without a manual” in February 2020, but Johnson initially refused to grant him the same diplomatic status as other national envoys.“Low levels of trust existed between the two sides — everyone has to bear their share of responsibility,” he said. “Trust begins with leaders. If there’s no personal chemistry, no common territory of conversation, there isn’t much we diplomats or bureaucrats can do.”Sunak’s appointment has sparked renewed hope of a resolution of the Northern Ireland protocol row, but Vale de Almeida urged caution, saying improved atmospherics alone would not end a dispute that has soured relations for several years.“The mood music has changed, the melody is nicer but we still don’t have the words of a new British song,” said the veteran diplomat, who will leave his London post next week. Officials on both sides are talking again about resolving the row over the Northern Ireland protocol, part of Johnson’s Brexit deal that covers trading arrangements in the region. But they remain some distance from entering the famous “tunnel”, where the final compromises are made.“There are always talks about talks and real talks — we are somewhere in between,” said Vale de Almeida, adding: “We’re not that far apart. We need now to focus on the landing zone.”Chris Heaton-Harris, Northern Ireland secretary, on Wednesday delayed new elections to the suspended Stormont assembly until next spring, telling the FT he was “very positive” about the prospects of a deal on the protocol early next year.Vale de Almeida warned that the EU would not adopt a new negotiating mandate — a key British demand — but said there was enough flexibility to find a deal because “we have not exhausted the potential of our offers”. To address the concerns of pro-UK unionist politicians about checks on trade between Great Britain and Northern Ireland — which are needed to avoid EU checks on the Irish land border — Vale de Almeida said Brussels would work to make them “as invisible as possible”.The bloc wants to use “real-time data” from Britain to assess potential risks from shipments across the Irish Sea, reducing the need for physical checks. But he said: “We can’t accept the situation where there are zero checks.” A deal over the jurisdiction of the European Court of Justice in Northern Ireland, which remains part of the EU’s single market for goods, is also being scoped out. That could leave the Luxembourg court with a reduced role in a broader dispute resolution mechanism.Vale de Almeida acknowledged the idea of striking a deal before the 25th anniversary of the Good Friday Agreement next year, and restarting the Stormont executive, should be a “stimulus”, but said it was not a deadline.He said he hoped that, once Sunak had navigated next week’s Autumn Statement, he would give impetus to a pre-Christmas push on talks, which — if successful — could unlock better relations across a range of fronts.Vale de Almeida previously admitted that British entry to Horizon had been paused because of the Northern Ireland dispute.But he said it was not too late to rescue the situation, adding: “My message to my British friends is to keep faith in us and we keep faith in you. Don’t do anything irreversible that makes association more difficult in the future.”Vale de Almeida admitted there was a darker scenario in which talks failed and the UK parliament enacted a bill to scrap the protocol. He said the bill, being considered by the House of Lords, “basically substantiates the violation of an international treaty”.The calculation in Brussels is that Sunak will oversee a deal because he wants to avoid a trade war with Europe during a recession.Vale de Almeida said a negative “Brexit effect” was now evident on the British economy and that he had not seen a single study suggesting that leaving the EU had made the UK better off.

He said British companies he had visited opposed the scrapping of old EU laws “for the sake of divergence”, adding that they did not want to face two sets of rules if they wanted to trade in Britain and the EU.Vale de Almeida said he would “never exclude” the possibility of the UK one day rejoining the bloc but that the priority was to restore trust and ensure the new framework operated properly.“Make it work — then, further down the road, we’ll see what our voters, what our leaders want,” he said. “It’s a dynamic relationship.”Reflecting on his posting, Vale de Almeida said he would miss the Premier League and English tea but that: “There has been too much drama. It was a traumatic divorce. My hope is that my successor has a more boring life than me.” More

There have been two elections of significance for the future of globalisation over the past two weeks. In one, a radical leftist relatively sympathetic to China was elected promising a sharp break with his predecessor, a business-friendly rightwinger who had signed one of the world’s largest-ever trade agreements. In the other, a traditionally mainstream conservative party with a historically free-market outlook is bidding for control of the nation’s legislature.Yet the former, the victory of Luiz Inácio Lula da Silva in Brazil, is almost certainly more positive for an open global economy than the latter, the Republicans trying to retake the US Congress. These are strange times. But it takes an appreciation of international rules and values more than vague deregulatory instincts to support the modern trading system, and the US in general and the Republicans in particular have long abdicated their role as defenders of economic openness.Lula has form in surprising those expecting a reckless, fiscally incontinent and protectionist administration. Ahead of his first election as Brazil’s president in 2002, the bond markets took fright, forcing the IMF to launch a then-record $30bn bailout. In the event, Lula’s government tightened fiscal policy even more than the IMF programme required, avoided default and saved the banking system. It was a similar story in trade policy. Brazil continued actively to promote its farm exports and was a highly competent and enthusiastic participant in World Trade Organization talks.This time round, Lula has signalled a closer alignment to Beijing than did his predecessor, the populist conservative Jair Bolsonaro. But he’s certainly not signalling a definitive leap into a big China-led geopolitical camp, not least because such a thing doesn’t really exist. The big middle-income countries all have to negotiate maintaining relations simultaneously with the US, EU and China. This was also true of Bolsonaro, instinctively pro-US but mindful of the three-quarters of Brazilian soyabean exports that go to China.In fact, the new president’s political and environmental stances also improve his position with Brazil’s second-biggest trading partner, the EU. Bolsonaro signed the Mercosur trading bloc’s preferential trade agreement (PTA) with the EU in 2019. But ratification stalled in Europe, due to its stated commitment to values-based trade, because of concerns over slash-and-burn agriculture in the Amazon.The EU has been dragging its heels and waiting for the election before coming up with a side agreement on deforestation. The deal will unlock ratification if Lula can live with some fudge to assuage his desire for more leeway on domestic industrial policy, and assuming EU objections are principled environmentalism rather than disguised protectionism from beef farmers. In September Lula predicted he could conclude the agreement with the EU within six months.Meanwhile in Washington, whether or not they take control of the House (and, less probably, the Senate), the Republicans remain a threat to an open world economy. Congressional Republicans are traditionally somewhat more positive towards PTAs than Democrats, though it was a Republican-dominated Senate that stalled the US’s last big deal, the Trans-Pacific Partnership (TPP) after it was signed by Barack Obama in 2015. Since then, the GOP has been dominated by an eccentric, aggressive economic nationalist in the form of Donald Trump — to say nothing of the threat posed to US and thus global political stability by its contempt for democratic institutions.Joe Biden’s presidency, which has kept tariffs and quotas in place along with Buy America-type local content provisions, has disappointed trading partners expecting a marked shift away from Trumpism. But, even given the underperformance of Trumpist Republicans in this week’s midterms, it’s hard to imagine any Republican president will risk alienating the base by returning to an instinctively open international economic policy.The reality is that among the main trading powers — including middle-income countries — the US is an outlier in its deep suspicion of globalisation and trade deals and its willingness to bypass institutions like the WTO. China is recalibrating its trading and investment relations with the rest of the world and in particular walling off its data and some of its tech-heavy economy. But Japan, the EU, South Korea, Brazil, Chile, India, the Asean countries, even Mexico under the populist Andrés Manuel López Obrador — none has shifted towards protectionism like the US.More leaders like Lula and fewer like the US Republicans would have been an eccentric recipe for protecting globalisation when he was first elected president of Brazil 20 years ago. But economically isolationist populism is now more of a threat in American politics than in most other major trading nations, and it poses a clear and present danger to an open world [email protected] More

When you’re in a budgetary hole, stop digging. This has been the attitude Jeremy Hunt has adopted since being appointed chancellor four weeks ago. Ever since September’s “mini” Budget, when financial markets lost confidence in the health of the UK’s public finances, it has been clear the country will pay a price for that mistake. The government’s average borrowing cost has gone up from 1.1 per cent at the start of the year to 3.8 per cent this week. The vast majority of this increase reflects global forces — rising inflation and higher interest rates — but the markets are watching. They will be more exacting in assessing UK budgetary plans than for most other countries and Hunt knows he must present a convincing case. In Thursday’s Autumn Statement he needs to demonstrate sustainable public finances, credible policy measures, and borrowing and debt that will be resilient to some further economic shocks. This is why the chancellor talks so frequently about “eye-wateringly” difficult decisions. Chief among these choices is what balance to strike between tax increases and spending cuts. It is almost certain that he will opt for the relatively easy options of allowing inflation to drag people into higher tax brackets, rather than putting up rates, and cutting some investment expenditure — scheduled to be at historically high levels — instead of squeezing public services too much. Those are in the bag, but will not be enough to close the fiscal hole, which Treasury insiders put at a little over £50bn a year by 2027-28, when the economy should be back to working normally. The remaining measures will reveal whether Hunt has prioritised good economics or smart politics in this statement. Economics suggests he should front-load the extra pain, putting in place almost immediate spending cuts and tax increases similar to the programmes followed by Norman Lamont and Ken Clarke in the early 1990s. That would not necessarily deepen the coming recession, since the Bank of England is there to moderate demand and offset a fiscal contraction with interest rates that are lower than they otherwise would be. With interest rates at 3 per cent, the BoE has scope to loosen monetary policy if necessary because the immediate budgetary tightening is sufficiently aggressive. Let us be clear. The UK’s central bank thinks a recession is needed to tame inflation, but there is no need for it to be deep, so long as companies do not seek to push prices up excessively and workers moderate pay demands. In this scenario, by the next election (which has to be called by late 2024) inflation would probably be under control and there would be scope for a period of faster than normal growth. Front-loading the budgetary repair job would have been the necessary step, instantly making UK economic policy credible. There might even be some further gains to be enjoyed from financial markets looking favourably on prudence, further lowering borrowing costs. The problem with front-loading is that it is terrible politics. Immediate tax rises and spending cuts would be unpopular with Conservative MPs and across the country. Sorting out the public finances would put the UK in a better position for the second half of the decade, but that’s when Labour is likely to be in power. There is therefore a risk that Hunt backloads difficult decisions to 2025 and after and minimises the immediate political pain from fiscal consolidation. If Labour wins the coming election, it inherits weak public finances and huge demands for better public services. Financial markets might well think that this government pledging that the next one will run sustainable public finances is not credible and, once again, punish the UK. Hunt’s big choice therefore is economics or politics. It will be the making of this chancellor. [email protected] More