17 February 2025: Greene warns of the inflationary effect of tariffs

Megan Greene, an external member of the Bank of England's Monetary Policy Committee, told reporters last week that she is “particularly concerned” about the inflationary effect of Donald Trump's threat to impose tariffs on the U.S. imports of several products.

The twenty-five per cent tariff on steel and aluminium will come as a blow to the UK steel industry, which is going through a significant process to bring its blast furnaces up to date as it tries to replace inefficient and polluting coal-fired furnaces with modern electric ones.

However, the UK Trade and Industry Minister said on TV yesterday that it would be difficult for the U.S. to replace the UK as the supplier of several niche products that it imports, such as the “skin” used for the hull of submarines produced in Sheffield.

Greene discussed how the UK could be affected by unilateral U.S. tariffs on several countries, including the UK, and the resulting trade fragmentation, noting that the UK is highly integrated into the international trading system, with the US its largest single-country trading partner.

"Our trade ties are profound with the EU, both directly and as a result of our joint participation in far-reaching global supply chains," she said. "But this does not mean we are immune to developments elsewhere. The US remains our largest single-country trading partner and a key link in the supply chains contributing to UK production.

"Furthermore, the UK has a relatively high average import-intensity of goods components, suggesting global shocks in these sectors are likely to have a direct and potentially large impact on inflation."

She added: "As a monetary policymaker, I am particularly concerned about the potential inflationary impact of such shocks”.

Exports to the U.S. account for around 8% of the UK GDP, so any disruption to the flow of goods could have a major effect on the economy, both growth and inflation.

The UK is in a weak position if Trump follows through on his threats to countries that impose “sales tax” on exports since it is not in a position to retaliate as the European Union and China are. UK imports from the U.S. are primarily in services, and any disruptions would harm it, especially in the biotech and AI sectors.

The Pound posted a fresh eight-week high around 1.2600 against the US Dollar (USD) in Friday’s North American session. The GBP/USD pair strengthened as the US Dollar slumped after the release of the US Retail Sales data for January.

The latest inflation data will be published on Wednesday, with the market expecting the headline rate to rise to 2.7% from 2.5% last month. That will be preceded by the January employment report, due tomorrow, with the claimant count likely to have risen as the threat of stagflation remains a distant possibility.

The pound closed at 1.2586 on Friday, which was a significant increase from its opening level of 1.2398.

In his six-monthly testimony to Congress last week, Fed Chair, Jerome Powell, accepted plaudits from its members from both sides of the house for his work in ensuring that the economy avoided a recession in the post-pandemic period.

He gave an honest appraisal of the current state of the economy, commenting that although 100 basis points have cut rates since the middle of last year, he and his colleagues on the FOMC are likely to remain cautious since they have no advanced knowledge of the inflationary effect of policy decisions from the new Administration.

Powell also received the support of Congress in his battle to keep the Central Bank free from “political influence.”

Last week was a whirlwind of economic and political events that kept the markets on their toes. From tariff concerns voiced by Sen. Mitch McConnell to Powell’s firm stance on inflation, the week was filled with significant developments.

Senator Mitch McConnell expressed his concerns over President Trump's tariff policies, warning of a potential trade war and subsequent price inflation for U.S. consumers and businesses. McConnell’s concerns were voiced in an interview published in a regional newspaper.

The latest retail sales data was published on Friday, and it saw a significant fall from the December numbers. Sales fell by 0.9% in January, following a rise of 0.7% in December. This will have caused the markets to reconsider its more hawkish view of the Fed’s rate-cutting possibilities.

Market commentators didn’t expect a rate cut until July at the earliest and possibly not until September, but if consumers are becoming more concerned about rates staying at their present levels for some time and tempering their spending plans, the Fed may have to reconsider.

However, Federal Reserve Bank of Dallas President Lorie Logan urged policymakers to remain cautious in the coming months, reiterating lower inflation wouldn’t necessarily prompt further interest-rate reductions.

“Even if we do get better data, and it does look like it’s coming close to 2%, I think we should be cautious,” Logan said Friday during a moderated discussion in Palm Desert, California. “Because if the labour market and the overall economy is strong, even in that environment, it doesn’t necessarily mean there’s room to cut rates further.”

Logan spoke before the release of the retail sales numbers, which drove the dollar lower.

The Dallas Fed chief’s comments echoed those she made last week. Logan previously said interest rates may already be near neutral, a stance of policy that neither stimulates nor restrains economic activity, countering the near-term need for further cuts even if inflation abates.

Weak Retail Sales data is likely to force traders to make fresh Federal Reserve dovish bets.

Currently, the Fed is expected to keep interest rates steady in the next three policy meetings, according to the CME Fed Watch tool. While there is an almost 50% chance that the Fed can cut interest rates in the July meeting.

Notwithstanding Logan’s comments, which will be either countered or supported by three Fed Presidents who speak later today, the Fed’s intentions are still unclear.

The dollar index fell to a low of 106.57 and closed at 106.67 in the wake of the weaker-than-expected retail sales data. This week is likely to be no less volatile as economic data mixes with government policy decisions to create a potentially explosive cocktail.

The news that Russia and the U.S. will meet in Riyadh, Saudi Arabia for talks on ending the conflict in Ukraine, will have been a major slap in the face for the European Union. However, it shouldn't be a significant surprise that President Trump has decided to lock Brussels out of the talks, given that he believes that the time for talk has ended and the time for action is now.

There is no doubt that France and Germany would want to have some say in the negotiations between the two, but given the Union's inability to make decisions, it is likely that they will be presented with a fait accompli.

Even when he was presented with the possibility of being ignored, French President, Emmanuel Macron, could do little more than call an emergency meeting, held in Munich, yesterday.

Higher U.S. tariffs on European exports are likely to have a negligible effect on euro area inflation, a top European Central Bank policymaker said last week, adding the main risk remained that of medium-term inflation falling below 2%.

In the text of a speech prepared for Italy's annual Assiom-Forex financial conference, ECB Governing Council member Fabio Panetta also called for policy decisions to be "supported by communication focused on the medium-term outlook for the real economy and inflation".

Panetta, who is Governor of Italy's Central Bank, said the main threat to price developments came from energy markets, where prices, especially for natural gas, are rising amid increased volatility, warranting close monitoring.

However, "overall, the available indicators seem to suggest that the predominant risk remains inflation falling below 2% over the medium term," he said.

A weakening of the euro in response to the introduction of higher U.S. tariffs and any retaliation from Europe, Panetta said, would be countered by a slowdown in the global economy and by China diverting goods hit by the tariffs to European markets.

However, as the EU moves towards more inward-looking trade arrangements, the capacity of China to increase trade with Brussels will be impaired.

The full implementation of the tariffs announced before the U.S. election, followed by retaliatory measures, would shave 1.5 percentage points off global economic growth, Panetta said.

"For the euro area, the impact would be more limited -– around half a percentage point – but Germany and Italy would be more affected due to their strong trade ties with the United States," he added.

This was a shift from EU considerations which on the one hand consider the EU as a single entity while, on the other, need to consider individual arrangements made by its members such as Germany and France.

The level of growth seen in the Iberian Peninsula over the past year bears testament to the potential for growth from trading in goods and more particularly services between EU members.

The Euro rallied to the top of its recent range last week, but traders will be cautious given that it has made similar highs in the past three weeks.

It reached a high of 1.0514 and closed at 1.0492 as traders expect more selling on a break of 1.0520.

Have a great day!