Welcome to the Merryn Talks Money Market Wrap, where we

talk about the biggest moves in markets this week and what's been driving them.

I'm John Stepek, senior reporter at Bloomberg, and author of the Money

Distilled newsletter, and I'm filling in for Merryn this week because she's on

holiday. So joining us this week is Simon French,

a friend of the pod and also the Managing Director, Chief Economist and

Head of Research at Panmure Liberum, the UK's largest independent investment

bank. Simon welcome back.

It's lovely to have you here, John. It's great to be here, thank you.

And what do you think of the studio we've gone upmarket just especially for you.

Oh, this is terrific. And thank you very much, Adam.

I mean, Merryn's not here. She's on holiday, but she's missing out.

Isn't she? On this?

Yeah, yeah, we've got surroundings. We got.

She's going to be disappointed, but, um. Yes.

Today I thought we would have a chat about, uh, we'll start talking about the

UK energy cap because we just get the new cost of our bills coming in.

Uh, just a wee chat about what's going to happen with inflation and maybe how

that's going to affect the consumer. And then I thought we should have a chat about gilt markets and

the Labour leadership battle and Tony Blair's, uh, sort of interesting

intervention in that today. He's written a big, long letter, uh,

basically talking about what the Labour Party needs to do to to get serious, um,

about winning elections and getting the country going.

Um, but let's start with the energy cap.

So from July, household energy bills are going to be going up by a substantial

amount. Um, and I really just wanted to ask you

about what you think that's going to do to inflation and the Bank of England and

the UK consumer from here. Yeah.

So a bit of context here. The energy price cap for the second

quarter of the year, about £1,640 for the average dual fossil fuel household.

Yeah. This is important when people talk about

this because I think people often get confused and they still get confused.

But the energy price cap is for the average household.

Yes. So the price is actually per unit of

electricity and gas that you use. So if you're wanting to know what your

bill is going to be, it's going to be that times the amount of energy you use.

It's not a cap. When you know £1,800 is not the maximum,

regardless of how much energy you use. So I think that's that's important for

people at home if you think that's important for people home.

And also the fact that this gets reviewed every quarter used to be done

every six months. And therefore obviously the peak energy

usage is next, is coming into the winter period.

And this is for probably the quarter where energy is least used by

households. So it is not just this move.

And we'll come on to talk about this, but is movement.

So potentially in Q4 into Q1 next year, that are probably more material for UK

household spending and of course for inflation.

And you ask what the transmission mechanism is here.

Well, there's an arithmetic change from the fact that about 4% of the CPI basket

is made up from household energy, and that going up by 13% quarter on quarter

and about 20% on the year will mean at about 0.4% 0.5%.

Headline CPI is correct, but to to move to the transmission

mechanism through to monetary policy is that is a known effect.

And it's the type of thing which the Bank of England will be quite

comfortable looking through as something relatively.

I'm going to use the word transitory, though.

What we worry about, what bank central banks worry about certainly now and did

worry about in their defense back in 2022.

The last time we had an energy price shock is those second order effects.

Yeah. And when you're trying to understand how

high inflation will go and whether monetary policy has to respond, it's

whether those second order prices in manufacturing and construction in

services feed off the initial impulse. So companies, do they have the pricing

power to retain their margins? Do workers have the negotiating power to

raise their wages to maintain their value in real terms?

Is demand strong enough to withstand all this?

And I think that is where when trying to get to the conclusion why,

central banks, the Bank of England particularly are unlikely to respond in

anything like the same way as they did in 2022, because the demand conditions are

much softer, particularly as the excess savings that a lot of households, not

all households, but a lot of households, have built up through the pandemic.

That is no longer the backstop to their demand.

That was very prevalent at the start of 2022.

Basically we would need a stronger economy to generate second

order inflation. So the kind of bad news is good news

element is that the economy is just not strong enough to have people, you know,

companies pushing through their prices and people able to demand higher wages.

And so the bank, That's why the bank will look through it.

I think that's right. And I think we're coming on to talk

about the bond market. And there's a vigorous debate among you

and me sometimes engage on this on social media

is what when you decompose the movement in gilt yields.

How much is that is responding to inflation versus political risk?

And clearly, um, looking at the likely Bank of England response will influence

the short end of the gilt curve. And we have seen as to your point on bad

news, is good news. When we saw some pretty soft jobs data

out of the UK economy last week. So illustrating some certainly weakness

in hiring intentions amongst firms that started to price out some of the rate

increases that have been pencilled in. And if you interpreted literally the

yield curve for the short end for the second half of this year, that makes the

point that bad economic news probably limits those second order effects.

And therefore the urgency for the Bank began to respond to this kind of energy

led inflation. I think from that point of view, do you

think those lately it be up? You know, the Bank of England will just

be able to get away with no interest rate hikes this year.

I think we should have central view on it supply central case.

And um I think that prior to the last monetary policy

committee meeting was my view. I haven't heard anything from the MPC

who of course now produce. And I think it's a very welcome

development, qualitative comments from each of the nine members on how they

interpret the inflation and the growth picture.

And most of the MPC members talked about financial conditions, the curve, doing

some of the heavy lifting. Because if you take listeners back to

the start of the year, the curve was pricing in a couple of rate cuts from

the Bank of England, and therefore it's something of a whipsaw to start pricing

in, um, rate increases. And of course, the real interest rates

faced by businesses and households in terms of offered rates from lenders have

responded to that. So mortgages have become they offered,

interest rates have moved higher, and that is doing some of the policy work

that otherwise would be required of bank rates.

We also need to acknowledge that four years on from the last time we had this

energy price shock, the balance, the balance sheet of the Bank of England is

in divestment mode. It's reducing the amount of held gilts

by about £100 billion a year. At the time of the last of the last energy shock

it was still accruing assets. It was still buying gilts again.

That transmission through tighter financial conditions is doing some of

the heavy lifting. The MPC would like the market to do its

work for it, so they don't have to get its hands dirty to people they don't

know. I'm never going to say this, at least

not explicitly in the minutes, but that's the subtext, isn't it?

Yeah. I don't suppose it's fairly obvious

because the mortgage market rates are going up a lot.

Although I suppose the point now is that it sounds as if that slightly settle

down for the rest of the year, assuming that The Iran war aspect doesn't get any

worse. I mean, have you got any thoughts on

that? I mean, obviously you wouldn't have any

idea any more than the rest whether the Strait of Hormuz is going to open or not.

know, the the elements of notice there's a lot of infrastructure being built that

kind of helps to bypass the street in some ways.

Um, long discussion about. Well, I think it was using quite as much

energy. I mean, centrist and the Easyjet came

out and warned the other the, the, um, you know, it's summer bookings haven't been

brilliant. And that's, you know, on the one hand

you can see that's consumer weakness. But on the other hand, it looks as if a

lot of it is simply don't know people not really knowing what to do and not

wanting to, you know, take a flight whenever there's a war and not that far

away. Um, so what can we take a moment to

celebrate something? I know you think, uh, or you celebrate

as I do, the role of prices, the role of markets, of sending signals, to destroy

demand, to encourage supply. They send really crucial signals.

And as I know later in the podcast, we're going to talk about politics.

But I think politicians get in the way of those important price signals at

their peril. And what have events in, uh, the Gulf?

And indeed, events in Ukraine done. They've sent messages to agents across

the world, in both energy markets and energy adjacent markets, that they need

more resilience, more pluralism in terms of supply, um, the supply of different

sources of energy. And they're responding to that price

stimulus. You're talking about holiday makers.

They're responding to the messages to, you know, of potential constraints of

supply capacity in the airlines market of jet fuel by being more cautious in

that, um, demand picture. And that is enabling some of those pinch

points we're worried about in terms of supply.

To be somewhat mitigated. I also think give a bit of credit too,

if you like. Not just corporate UK but global, you

know, corporates, particularly in the travel industry.

Um, airline chief executive who turns out I know a bit more about their industry

than some of the Substackers is that we were only reading about a month ago who

are telling us there will be here these acute, uh, supply pressures by the end

of May if the straits weren't reopened, were it turns out that the and economic

supply chains, the energy supply chains are a little bit more flexible.

Uh, operators are a bit more flexible. When we first thought that is a good

thing, those messages politicians get in the way of at their peril, in my view,

and we need to be much more comfortable. Yes, I recognise there is political

fallout, always with inflation, but the message it tends to the supply side of

the economy is really, really important. And I think we perhaps can look at how

markets have cast or at risk markets have cast off some of the risks in the,

in the Gulf, um, in terms of being quite a celebration of

global supply chains. Yeah.

I mean, yeah, I mean, because it's interesting because obviously the, uh,

we have heard a lot about price controls recently.

Yeah. Um, particularly with regard to

supermarkets. Um, and I think you're right.

I mean, that says like in the object lesson, then the value price is a signal

and mechanism and, you know, basically saying if people look, you need to find

a different way to get hold of this or to use less of it.

Um, so yeah. Yeah.

Basically interfering with prices at your panel.

Um, which is a nice we bring us on to politics and support.

Um, so, so anyway, so Andy Burnham. Yeah.

Andy Burnham is, uh, the mayor of Manchester, and he's the kind of the

person who seems, at the moment, most likely to eventually become the leader

of the Labour Party and therefore the next Prime Minister.

Mhm. Um, and gilt markets are appeared,

eventually giving them a bit of a break in the last week or so.

A little how much of that stony and deep on them, and how much of it is actually

down the economy not looking like the is another question.

Um, but, uh, Tony Blair has stepped in too.

It's almost as if the gilt markets have faded away is something they worry

about. But now the kind of the spectre of

Labour's most successful prime minister, um, has kind of risen to to, uh, give

Andy a bit of a nudge in the ribs. Um, so what did you think in that?

So there's a big lay out that came out from the Tony Blair Institute by the man

himself, basically making a vague sort of wish list of what Britain should do.

Yes. And explaining why Labour isn't doing

it. And it needs to start doing some of it.

I mean, what was your what was your take on this, um, radical centrism?

I think it was interesting. I mean, there's a little bit of, uh, uh,

some very political ideology there, really, I think.

No, it's not totally just an oxymoron. So yes, it's a speech mixed up.

Yeah, yeah. Um, so what do I make of it?

Look, um, I am no Tony Blair or New Labour fanboy,

but he spoke a lot of sense. I felt in the latter.

There are some policy trade offs that are uncomfortable for what has been

called the soft left of the Labour Party that he, um, shines a light on, or maybe

holds a mirror up at um, on immigration, on net zero, on the world order, on the

relationship with Europe. It's a kind of, um, it's quite an essay,

isn't it? Of the big both structural challenges

facing the middle powers, and he references Mark Carney in his speech or

call to arms in Davos earlier in the year.

Um, but also, um, some of the shorter term political challenges and perhaps

some of the, the failings of, um, the prospective Labour leadership candidates

and the incumbents of not having the policy debates, which I think you and I

share this frustration ahead of ahead of the 2024 general election and trying to

make policy or have the debate with the public about some of the difficult

decisions on technology, the cost of ageing, on immigration, on welfare

spending in parliament, in government, without a manifesto to backstop that

with which to use to to to whip your own party's not literally, but at least

metaphorically, is a real difficult challenge.

And to me comes back to the challenge Andy Burnham will have if he takes that

path you lay out, which is he wins the Makerfield by-election.

He wins the Labour leadership and he becomes Prime Minister.

On one side, he'll be boxed in by the bond market on the other side of the box

to him, by his own political brethren, and therefore the room for manoeuvre is

quite limited. And by the way, I think it is that

limited room for manoeuvre the bond markets have responded quite favorably

to, because they've read what has been revealed over the last couple weeks is

how much, um, how many limits there are politically and financially and his

ability to be particularly radical, be it a radical centrist or a radical

leftist or a radical Mancunian or whatever, uh, um, descriptor we want to

give it. And to some extent, markets are saying,

well, the status quo is not it's not great, but it's not a deterioration from

here. But this thing I want to run through

some of the things that I said, because I thought it was quite interesting

because, well, I mean, so we mentioned immigration and he says, uh, okay.

First of all is he said, I said something very pointy, which was he

said, we need to do whatever it takes to stop illegal immigration.

Um, and specifically mentions the small boats.

Yeah. So that's the first thing he says.

We need skilled immigration, but we need to stop the illegal stuff.

Mhm. He says that on energy we should focus

on getting cheap energy rather than clean energy.

So it's not going down the net zero. Do it quite as vigorously and drill for

more North Sea oil and gas that's in there aswell.

Um, what was the other thing that we want to mention them and their goal?

Um, it talks about how the the New World Order is actually not a new world order.

It's just the Americans finally being a bit more blunt about the fact that

Europe and the UK have an internal way in terms of how much of the UK is not

actually as bad in terms of defence, but saying, look, we need you guys to

contribute more because the world is getting a more dangerous place.

Mhm. And what strikes me is that he isn't

saying anything that I think most people outside of the actual Labour Party and

possibly those to the left of the Labour Party, would consider to be

controversial. I was seeing someone on Twitter this

morning and said, how do you get these messages across in a a populist world

without going beyond popular? And I was thinking we I mean, Nigel

Farage could have said half of this stuff and it's just basically, yeah,

he's only this. Yep.

We want to date to net zero. We want to get immigration under

control. And no, we don't think the Americans

have lost their marbles. They've just got kind of frustrated with

us. So I just uh, it strikes me as very odd.

So when you believe this is essentially evil, we see all of these things and

they just come across as being common sense.

Um, in the face of, um, I guess, uh, we're as if the Conservatives or Reform

had said that there would be a sense of, oh my goodness, you you can't see this

sort of are you climate

deniers of you racist for wanting to, you know, stop kind of illegal

immigration. That sort of response.

I want these points on the wing. Do you think any of this is actually

gonna help? Leave us to talk about this stuff in a

way that might change the policy. Let's take energy.

Mhm. Um, act a bit more sensibly on that.

Maybe at least let you know some of the licenses continue in the North Sea.

Depressingly, I feel it will not change the

preferences revealed and targeted from the current cohort of Labour MPs who I

have thought really since very shortly after the general election, um, that

they cut their teeth in think tanks and special advisers, most of them in a non

private sector background, during a period where those luxury beliefs on,

um, net zero on immigration, on the role of the United States.

Zero interest rates were, uh, all conditioning, uh, assumptions that could

allow those luxury beliefs to come with relatively little cost.

But they've all changed. All of that list has changed.

And what I struggle to see is how having set your stall out for different MPs,

they've sent their stall outs in different ways because it's actually

quite a broad. Yeah.

broad church the Labour Party, well that's not part of the problem for that.

It absolutely is. Having set your stall out on what you

really care about. Um, reversing out of that and saying the

facts have changed, the financial facts have changed, the geopolitical context

has changed. Population flow has changed.

You know, the war in Iran has changed these calculations.

Um, it becomes very, very difficult for, uh, the individuals it comes down to

those people to, to to to reverse course.

Um, Keynes said. Of course, famously, when the facts

change, I change my view. Keynes is not someone whose view is, uh,

at least not in terms of that quote, as something that this cohort of Labour MPs

show a huge affinity to. He was an unusual guy, so I think we can

thankfully give him that. Um, I mean, I guess then so coming back

to gilts, because the thing that strikes me is that, okay, it's one thing.

The gilts market may be thinking, okay, the status quo is all right.

So if we get kind of Burnham and he's going to toe the line, he's not going

to, you know, completely go off in one. But that then means he's basically going

to face exactly the same problem that Starmer's face.

And just no, he may be a more personable individual.

He may be slightly better at talking to, you know, he may be part of the Combs

thing they keep talking about, but is still going to face the problem whereby,

um, regardless. Okay, he may have taken the message of

the market on board. I don't think all of the kind of other

left MPs will have is still going to be stuck with things like being unable to

reform welfare. Yet another thing that Tony Blair said,

you know, we need to cut welfare checks. Um, so that kind of leaves is rumbling

along. It does for the next conceivably three

years. Why do you think that happens?

I just think we get a general election before the end.

Uh, I mean, uh, it feels like squeezing the

balloon, doesn't it? Because if you decide that's your room

to maneuver without a fresh mandate is very limited.

And I think if you want to do anything on some of the proposals in terms of,

uh, nationalization, on terms of property taxation and wealth taxation

that have been proposed by Andy Burnham. Um, it feels very difficult to do that

without a fresh political mandate. Yeah, but then you come in to lead your

party, and you, uh, announce early on that you're going to voluntarily trigger

an event that will probably make on current polling, three quarters of your

colleagues unemployed, you know, not a direct route as far as I can establish

to popularity, internal popularity. So, um, unfortunately, that conclusion,

therefore, is that the mandate bequeathed to Keir Starmer in the Labour

Party in 2024 will be the one that they will run with all the way through to

2029. And therefore any radicalism from Andy

Burnham will immediately face the challenge of, uh, legitimacy.

Bring it back to the bond market, which you open the question with is, um, I

think we also need to look at the other scenario where we've talked a lot about

Andy Burnham, but let's say he loses the Makerfield byelection.

Yeah. Which is possible, which the moment

doesn't. Look, I mean, this currently looks like

the the, the right of center right vote is being split between Reform and

Restore. And that's allowing Andy Burnham a bit

more gap to win. But if he doesn't I think the markets

would be worried about another candidate from see what they the self stance of

the soft left but probably more left that Andy some it's a character like,

uh, Angela Rayner or Ed Miliband who the bond market would respond negatively to.

So I think some of that compression of yields spread between the ten year gilt

and the ten year Treasury is a result of some more favorable polling.

Andy Burnham that actually means that some of those more, um, left wing

candidates from the Labour Party won't have to throw their hat into the ring,

which I think they would inevitably have to do if Andy Burnham didn't have a seat

in Parliament. So, I mean, knowing that, I mean, what

would a crisis actually look like? Because I assume, let's say something

happens, let's say Burnham loses. Um, and let's see that then.

Angela Rayner, or Ed Milliband decide that that's that opportunity.

And rather than see coming to power and saying okay we'll stick with Rachel

Reeves as Chancellor. Just to keep you folk happy

Yeah. They stick someone to the left of them

then. Um, I mean, at what point would you say

I mean, the once Liz Truss moment are vastly over used?

Yes. Um, and I always go back to.

It was about LDI But you know what point you say?

Actually, this is where that kind of doom loop could start with only 6% in

the ten year run. What are we thinking about?

Well, I said, I thought the 5.5% on the ten year is a pain threshold for both

the public finances and actually potentially for the Bank of England to

have to step in as they did actually after the LDI, um, crisis of 2022.

Um, but um, and these may be able to pull the tapes in six months time if

this I think this plays out different to what I anticipate, which is if this

scenario were to play out. I think bond markets are the most

rational of the, um, financial assets, um, that we look at.

And they would just somewhat, um, impartially just apply a higher

inflation premium for the UK economy for to own sterling assets.

And you can see that most obviously in gilts I think.

But you would also see it in um, you know UK focused equities, domestic

equities as well. Is that the policies that those two have

been associated with net zero in the case of Ed Miliband, the Rent Reform Act

and the Employment Employee Rights Act with from Angela Rayner.

Oh, all three of them seen as inflationary.

Yeah. Inflationary in energy markets.

Inflationary in jobs markets. Uh inflationary in uh London.

Property markets in terms of rents. That is not a good position for to sort

of set out your stall for a broader economic agenda.

And are the markets, as the gilt market, going to wait for those individuals to

set out their broader economic stall or just say, well, there's the signal.

The signal is that that will illustrate with the kind of a higher inflation

premium in the UK economy. And therefore we just priced things

accordingly, which is just an incremental increase on on gilt yields,

nominal gilt yields. Yeah.

And there's presumably that point. That's when everyone starts panicking

about the mortgage. And maybe that's what brings the next

government into line. Or and to your point on, there's two

responses. There's the private sector in terms of,

you know, a slowdown in demand because of tighter, um, credit conditions.

But then there's also the impact the next time the OBR forecast and those

widely seem to be November in the November budget.

And if you plug in those kind of yields, some of that 22, £23 billion of headroom

that the Chancellor left herself back in the spring will have largely evaporated.

And therefore we're back in that cycle, which I rather hope I think we both hope

had been left behind with that speculation day to day, week to week,

the taxes are going to have to go up or spending there have to be cut.

At which credit to Rachel Reeves, she doesn't get much.

But having rebuilt the last two fiscal events, uh, the headroom, we have seen a

diminution of that speculative cycle. If we get that back, that's not great

news for the economic momentum of the UK economy.

Yeah. Well, before we wrap up, is that is the

one policy the Andy Burnham, assuming he is the next prime Minister could bring

in, that would make you feel a little bit more upbeat.

The prospects for the economy, UK economy.

Yes. Um, and he has spoken about this, uh,

albeit he hasn't defined the exact parameters of it.

And this is a land value tax or a proportional property tax.

Um, I look at the £64 billion that the Exchequer raises off a combination of

stamp duty, land tax and council tax? And you think of them as two very poorly

designed taxes, stamp duty as a fraction, you know, desperate to talk

about stamp duty shares. But let's talk about some future

residential property. It's a fraction of £14 billion a year

fraction and then a £50 billion a year. Very regressive tax, uh, which is

council tax, which has been unreformed in the UK since the early 1990s.

And if you swept those away and replaced it with a proportional property tax, you

incentivise rightsizing of the property stock.

You incentivise moving. Uh, and it's a broadly progressive, uh,

move. I don't pretend it is easy.

I don't pretend there aren't losers associated with it in terms of

distributional losers. Um, but as a pro-growth initiative,

because effectively you are engineering new supply, particularly by right

sizing. And you're generating VAT receipts from

high number of transactions, home improvements, etc.

that feels to me a very, very pro-growth, uh, policy.

And the question really for Andy Burnham is whether without a fresh manifesto and

mandate, whether he can push through something that politicians have ducked

for 35 years. I mean, that is that's a fascinating

one. Um, and I can see well, it touches on

that thing that it's so important to connect UK voters.

Isn't that the kind of place the houses and the their.

The house is a castle. When the, uh, was it's always the can,

uh, the can the paint the 11 in some way out

in Mayfair who is a cash pool and asset, kind of vastly wealthy who then gets

hit. But I suppose if any she the government

can push through that sort of, uh, issue.

Then there's, there's quite possibly a level one.

So I know that's an interesting one. But I think if you look at thematically

what is wrong with the UK economy. It has been the sclerosis of our supply

side and property and land most obviously has been, um, underdeveloped,

uh, underutilized. There is, but it has become a store of

value rather than an asset to promote geographical mobility, labour mobility,

uh, aspiration. And therefore in that part of that, like

part of that legacy is a result of how it has been taxed, really poorly taxed.

And so at some point, and I hope it's not in crisis, I hope it is proactively

you address that and address one part of the three legs of the stool with energy,

um, and the, and um, the, uh, the capital markets being the other two,

where the supply side has been neglected for decades.

A growth story and this is maybe we end with this.

Something else Blair said in his letter is, um, you know, if growth is your

primary mission, you don't add more frictions to generating growth, which is

basically the criticism of the last two years of the Labour government having

come in promising new growth, was their primary mission.

They've introduced a lot of policies that have made growth in the private

sector even harder to achieve. Excellent.

Well, so fingers crossed for a Land Value tax then?

But but if you're listening Mr. Burnham, you have to replace the existing

taxes, not add an extra one on top 100%. Thanks very much, Simon, for being on

the show. It was a huge pleasure.

Thanks, John.