1 October 2025: The Chancellor may be forced to remove the two-child benefit cap

The UK could flirt with a recession during the fourth quarter as the economy faces a “triple whammy” of dangers even before Rachel Reeves presents her budget next month.

Before Reeves addresses two significant issues, namely, the two-child benefit cap and the triple lock on the state pension, she must consider higher borrowing costs, cautious consumers, and lower growth. Borrowing costs continue to rise, mainly due to the Bank of England's ongoing quantitative tightening policy, as it divests itself of its government bond holdings.

Consumer spending is slowing as household budgets continue to be squeezed by “sticky” inflation, a term MPC member Catherine Mann labelled as persistent yesterday. The Committee’s resident hawk was quoted as saying Britain's inflation rate had become persistently high, although that did not mean further interest rate cuts were entirely off the table.

"For those of you who might have read the August Monetary Policy Report ... there was an inflation persistence scenario in that," Mann told a seminar organised by the Financial Times and S&P Global Market Intelligence.

Her colleague, Sarah Breeden, concurred, saying that UK inflation is too high and the Bank of England will need to steer a challenging course to bring it down without triggering a painful downturn that hits jobs; interest rate-setters have said.

The two-child benefit cap has become a policy that has stirred the same backbenchers who protested the measures in the welfare review that had to be reversed. At the same time, the triple lock on the state pension is a poison chalice for any Chancellor of the Exchequer.

The economy expanded by 0.3% between April and June, confirming a sharp deceleration from the robust 0.7% growth recorded in the first quarter of 2025. The Office for National Statistics (ONS) left its second quarter estimate unchanged, marking a steep pullback from the stronger start to the year.

The Q1 numbers were bolstered by increased exports by manufacturers, particularly of vehicles, to the U.S. in a front-loading measure designed to beat the Trump Tariffs.

While growth figures for 2025 remained unrevised, the ONS updated quarterly gross domestic product data throughout 2024. Despite these revisions, the overall annual growth rate for last year held steady at 1.1%.

UK business investment decreased by 1.1% in Quarter 2 (Apr to June) 2025, revised up from a 4.0% decrease in the provisional estimate. The most significant contributors to the decline in business investment were decreases in transport equipment and intellectual property products. ICT equipment and other machinery and equipment made a small negative contribution. In contrast, the only positive contribution came from different buildings and structures.

UK households bolstered their savings in the second quarter, according to ONS, which suggests consumers are cautious amid an uncertain economic outlook. The proportion of disposable income that households saved rose by 0.2 percentage points to 10.7 percent in the three months to June, the Office for National Statistics said on Tuesday. The household savings ratio is well above the 5.6 percent average in the three years before the pandemic. The ONS stated that increased wages and reductions in taxes on income and wealth primarily drove the rise in disposable incomes.

The pound managed a moderate rise on a day when the U.S. Federal Government shutdown became a reality. It climbed to a high of 1.3672 and closed at 1.3645.

The world’s largest economy is on the verge of switching the lights off, at least partially. If US lawmakers fail to reach a funding deal, large parts of the federal government will shut down.

Hundreds of thousands of workers won’t get paid. Vital data releases will be delayed. Political brinkmanship will be on display for the world to see.

For Americans, shutdowns mean shuttered parks, longer queues for services, and uncertainty for families relying on government paychecks. But the question for the rest of the world is simple: does this political drama matter beyond US borders?

A shutdown doesn’t mean America stops functioning. The military still runs, Social Security cheques still go out, and law enforcement remains in place. But “non-essential” government staff are furloughed—forced to stay home without pay. Others must work without salaries until Congress agrees on a budget.

This national game of brinkmanship is becoming an annual event, right up there with Halloween and Thanksgiving, as the President and Senate face off in a show of strength.

The impact builds week by week. Economists estimate that each week of shutdown trims about 0.1% off US quarterly economic growth. In 2018–19, a 35-day shutdown, the longest in history, shaved off around 0.4% from economic output. Once workers return and receive back pay, much of that loss is clawed back.

Markets have also proved resilient. Since 1976, the S&P 500 has actually risen in the year after shutdowns. In the last major episode, stocks climbed more than 10%.

The 55-to-45 vote in the Senate, falling short of the 60 votes needed to advance the legislation, all but ensured that U.S. government agencies will have to discontinue all but "essential" activities, such as law enforcement, starting today, potentially disrupting everything from air travel to the monthly jobs report.

Chicago Fed President Austan Goolsbee commented that U.S. central bankers would have to seek alternative data sources to consider at their October 16-17 policy meeting if upcoming government reports on jobs, inflation, and other economic aspects are suspended due to a government shutdown.

The self-funded Fed would remain open even if the rest of the government closes. "It pains me that we wouldn't be getting official statistics at exactly the moment when we're trying to figure out whether the economy is in transition," Goolsbee said.

President Donald Trump on Monday ordered significant new tariffs on wood and various wooden products, including imported lumber, timber, kitchen cabinets and upholstered furniture – potentially adding costs to home building and furnishing, which have surged in price in recent months.

In a Presidential Decree, Trump announced that the United States would impose a 10% tariff on foreign softwood lumber and timber, which are used in a wide variety of building materials. He also announced a 25% tariff on kitchen cabinets, vanities and upholstered wooden furniture.

Those rates are set to go into effect on October 14.

The dollar index continued a three-day slide, which could remain until the Federal Shutdown ends. It fell to a low of 97.64 and closed at 97.63.

European Central Bank chief Christine Lagarde said yesterday that US tariffs had not hit the eurozone as badly as feared, but warned new risks could lie ahead in an uncertain world.

Europe, which runs a substantial trade surplus in goods with the United States, was one of US President Donald Trump's primary targets as he imposed a barrage of tariffs on friends and foes alike. The European Union struck a framework deal in July, setting tariffs on most exports to the United States at 15%, far higher than before Trump's return but below eye-watering levels that the American leader had occasionally threatened.

This year, Europe has been at the "receiving end" of "trade deployed as a tool of power", Lagarde said in a speech in Helsinki. Most had assumed that US tariff increases "would trigger a major adverse shock to the euro area economy," she said. But those "assumptions have not been borne out".

The European Commission considers itself still in negotiation with the U.S. to either remove or substantially reduce the tariffs. Still, President Trump believes it is a done deal and has moved on.

German Chancellor Friedrich Merz opened his coalition government’s first cabinet retreat on Tuesday in a bid to revive the EU’s largest, but ailing, economy after promising an “autumn of reforms” earlier this month.

The Chancellor pledged to put Berlin back on a “growth trajectory” and make the country “attractive again for investment.” However, he added that it was a “collective mission” that required all ministries to be on board.

Economic competitiveness and modernisation of the German state are taking centre stage at the two-day meet that brings together the federal ministers at Villa Borsig, on the outskirts of Berlin.

The Christian Democrat-Social Democrat coalition is considering concrete steps to reduce bureaucracy, according to a document prepared by staff at the party’s headquarters. Proposals include cutting administrative costs by a quarter, reducing the federal workforce by 8%, and enabling same-day company registrations.

Ministers will also discuss fiscal policy, productivity, regulatory barriers, the green transition and infrastructure.

“The long-overdue modernisation of our state must now really move forward quickly. We must review public services; they must become more efficient and less complicated,” Merz said.

To achieve that, Minister for Digital Transformation and Government Modernisation Karsten Wildberger pledged a more “subtle” approach than Elon Musk’s headline-grabbing DOGE efficiency crusades.

Inflation in Germany and France, the eurozone’s biggest economies, rose in September, data showed Tuesday, fuelling expectations the European Central Bank (ECB) will not make further interest rate cuts in the coming months.

Annual inflation in Germany rose to 2.4 percent last month, according to preliminary data from the federal statistics agency Destatis, up from 2.2 percent the previous month.

The figure, slightly above analyst estimates, was driven by increasing costs for services and goods.

French annual inflation accelerated to 1.2 percent in September, up from 0.9 percent in August, also driven by rising service costs, according to the INSEE statistics agency.

Meanwhile, in Italy, the Eurozone’s third-biggest economy, annual inflation remained stable in September at 1.6 percent, according to official data.

Following a string of cuts to support the struggling eurozone economy, the ECB has kept interest rates on hold for its past two meetings, with inflation hovering around its 2% target.

Experts believe that the latest eurozone data shows that the ECB was correct in its decision to end its monetary easing policy, especially as price pressure in the services sector is once again proving persistent”.

The ECB will hold its next rate-setting meeting on October 30 as most economists expect it to hold rates steady until at least the end of this year.

The Euro continued its rally yesterday. It climbed to a high of 1.1761 and closed at 1.1734 as the market awaits a conclusion to the U.S. Federal shutdown.

Have a great day!