This week’s UK inflation data for December came as a surprise. Quite why remains a mystery. In the latest numbers already published prior to ours, inflation in Germany and the eurozone and the US had all ticked up. Why the UK’s doing the same, rising a miniscule 0.1 percentage point from 3.9% in November to 4% in December, was ‘unexpected’ or ‘surprising’ and prompting an investor rumpus, is therefore curious. What might have been more surprising would have been if ours were still falling while everyone else’s was heading in the opposite direction.

As ever, the bond markets are the barometer for market sensitivity to inflation data and investors’ perception of what happens next to interest rates. A more likely explanation for the reaction of surprise is the markets’ agenda for lower interest rates (and sooner) being temporarily frustrated: having enjoyed a significant rally in bond prices in the fourth quarter of 2023 (reflecting a drop in yields in anticipation of falling interest rates) and recouping some of the significant losses incurred in 2022 and much of 2023, as if we did not know it before the upward blip in inflation confirms that the pathway to the 2% target is neither smooth nor linear. Bottoming on 27th December, all major government bond yields have since risen sharply in the New Year, recovering between a quarter and a third of the falls since mid-October (the corollary of which is prices giving up as much of their fourth quarter gains). As we said at the end of 2023 and again at the beginning of 2024, such a wide spread between market expectations and real policy outcomes was confrontational and unsustainable: both could not simultaneously be correct. As is invariably the case with economics, however much the accusation is that it is rearward-looking, the official reported data always provides a sense-check between reality and aspiration or hope.

Thinking Great Thoughts in Davos

Which neatly segways strategically to Davos and the World Economic Forum. The WEF is the annual jamboree of the political, economic and business establishment; the Alpine retreat to which The Great and The Good repair for a week of talking shop and mutual backslapping (minding the occasional sharp elbow or political stiletto) and with the possibility of some winter sport thrown in. If we sound cynical it is not to deny the need for leaders to discuss major supranational subjects. On the 2024 agenda: “Achieving Security and Cooperation in a Fractured World”; “Creating Growth and Jobs for a New Era”; “A.I. as a Driving Force for the Economy and Society”; “A Long-Term Strategy for Climate, Nature and Energy”; all to be resolved in four days. That does not stop national politicians using it is a forum for domestic political grandstanding: UK Chancellor Jeremy Hunt shamelessly trailing UK tax cuts ahead of the March Budget, or his likely successor Rachel Reeves attempting to expunge the idea that Labour is bad for business.

However, Davos has an uncanny habit among electorates of appearing detached. It unwittingly reinforces the distinct feeling of them-and-us: ‘we the elite will be discussing matters too complex for the great unwashed to comprehend; don’t worry your pretty little heads, people.’ The Davos conference is only upset occasionally when, for example, Greta Thunberg turns up and delivers a great big kick squarely in the political proverbials about climate change; or The Donald, completely connected to the grass roots, appears liberally lobbing verbal hand grenades with the pins taken out, as he did in 2020, and cheerfully watches the trail of diplomatic destruction in his wake; or in 2017 the Chinese General Secretary surprising the world with his presence and letting us all into a great big secret that he is the living embodiment of sshhh, whisper it…..a globalist (to which he might have added, but did not, ‘and by the way, comrades, lest there be any confusion: when I say I’m a globalist, what I mean is that by 2049 I expect all roads globally to lead to Beijing’).

Christine Lagarde, thoroughly at home at the Alpine retreat

At the World Economic Forum this week, Christine Lagarde, President of the European Central Bank, spoke in a Bloomberg interview of the likelihood of lower eurozone interest rates from the summer. Even if this disappointed the markets that rates will not be cut sooner, after Jerome Powell at the US Federal Reserve in December she becomes the second of the world’s principal central bankers to be smoked out of her formerly entrenched position that inflation is the enemy, it is not yet beaten blah-di-blah-di-blah. Only the Bank of England obdurately holds the line now.

Among her peers at the Fed and the Bank, Lagarde is unusual: she is neither an academic nor a career economist; instead, she is a lawyer by background, and as a former French trade and agriculture minister, a politician to her fingertips. And as we discussed in last week’s column, akin to simultaneously juggling and dancing on the head of a pin, she has the unenviable and impossible task of successfully managing 20 countries’ economies with no fiscal union but with one interest rate; but while her peers rise above the humdrum of national politics, even though Lagarde is careful to guard the ECB’s independence from political influence, her well-tuned, innate political antennae are always twitching.

We must do something; this is something; therefore we must do it

Taking into account those strategic themes on the Davos agenda, it is not difficult to imagine that with the principal eurozone economies flat-lining, and populist politics spreading across Europe thanks to the common preoccupations with immigration and climate change and actively challenging and increasingly defeating established political parties, Lagarde must be thinking of what the ECB can do to help keep the European political project on an even keel. The intellectual struggle is palpable: how to back-track on the need demonstrably to beat inflation (when the target has not yet been met and the latest data has gone the wrong way) and stimulate economies and employment. Despite the potential for the need to create growth and manage inflation being potentially contradictory, and with only two strategic levers at her disposal (interest rates and liquidity in the form of bond purchases known as quantitative easing or QE), it is not difficult to see why she now appears in a hurry to begin reducing interest rates and loosening policy.

Leaving aside credibility in the new era, her problem is that for seven years from December 2015, she and her predecessor, Mario Draghi, deployed ultra-loose monetary policy in the eurozone including a negative central bank deposit rate which along with aggressive QE ultimately led to a multi-year period of negative government bond yields. Unlike Quantitative Easing in the UK and the US which had principally been deployed as a financial defibrillator to shock the financial system out of its near cardiac arrest in the Global Financial Crisis, the ECB’s implementation of QE was designed to stimulate economic growth. But thanks to that lack of fiscal union and a multiplicity of frictional elements including tight regulation in the financial and economic fabric, the eurozone economy failed to respond to the massive stimulus. GDP remained disappointingly slow and sub-par to the point where far from having a multiplier effect on the economy, every marginal euro of QE was obeying the law of diminishing returns tending towards zero. In economist speak, it was a “failure of the transmission mechanism”. Through its mechanics, QE created asset price inflation and caused valuations in different income-generating assets (bonds, equities, property) to begin positively correlating as each class became successively more expensive and investors moved on to the next to find cash income at a reasonable value; but it failed to percolate down to the real economy and the consumer to deliver sustainable growth, let alone accelerating economic activity.

The question is, before she and her peers embark on the loosening phase of the monetary policy cycle, what have they learned from a decade or more of experimenting with what at its inception was regarded by orthodox economists as heretical policy? What will the central banks do differently next time that avoids the economic pratfalls and indeed the unintended social and political consequences that became only too evident in the post-GFC economic environment. Time will tell.

Who’s there and who’s not

As an aside, Davos is not just about who is there, although these include Emmanuel Macron, never one to avoid the international limelight; Ursula von der Leyen, a civil servant with a presidential title still in search of a United States of Europe over which to preside; Jens Stoltenberg, the time expired NATO Secretary General who can’t find a successor; António Guterres, Secretary General of the anything-but United Nations and serial climate hysteric; the impressive but visibly weary Volodymir Zelensky returning Oliver Twist-like with his begging bowl pleading for more help; and a host of others including curiously in the current circumstances, the Iranian foreign minister, and the new firebrand Argentinian prime minister.

Equally revealing is who is not there, or who sends the B Team instead. Putin obviously is absent in person because he’s on an international sanctions list and would promptly be arrested; but in deep domestic trouble, also absent is Olaf Scholtz from Germany; and our very own Rishi Sunak, currently preoccupied navigating his Rwanda deportation policy through Parliament. Although the Americans nearly always send a delegation (this year led by the frenetically peripatetic Secretary of State Anthony Blinken) but unlike Donald Trump, Joe Biden himself has never been while President. Given he put a firm marker down at the G20 conference in India last September about the future being “the Global South”, it is also surprising that while sending a very on-message cabinet team, Prime Minister Modi himself is absent to reinforce his determination to be one of the big players. China has sent the biggest delegation under the leadership of the Prime Minister but the General Secretary, Core and Helmsman, is nowhere to be seen: he personally has nothing to add.

As an exercise in people-watching, Davos is about as fascinating and surreal as it gets. And a year from now, they will know whether Donald the Terminator Trump will be back. Hold on to your hats, it could be a bumpy ride!

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