2 February 2026: Bailey faces more inflation problems

The U.K. economy faces the risk of a "significant recession," raising the potential for a much more aggressive policy easing cycle by the Bank of England. British economic growth indicators remain weak, with business confidence and job data raising recessionary red flags.

Moreover, the U.K. labour market is deteriorating at a worrying pace. In many regards, it is already looking recessionary; unless the data improves, unemployment risks are pushing the UK economy into recession."

At the same time, wage growth has slowed, and service price distribution has normalised, fueling projections that underlying inflation will fade down to the BoE’s 2% target this year.

With these trends in mind, the BoE is likely to meet market expectations for 41 basis points of interest rate cuts this year. In 2025, it lowered rates by 100 basis points.

Expect the MPC to keep the Base Rate unchanged at 3.75% at this week’s meeting. Since December, labour market data have shown continued softening. Still, progress on inflation has not been sufficient to justify immediate policy easing, particularly since rates are presently close to neutral, which raises the bar significantly.

The MPC remains a divided committee. Three of the past four meetings have resulted in a 5-4 split, with Governor Bailey breaking the ties. In the December minutes, the Governor noted that he sees “scope for some additional policy easing” if there is convincing evidence that inflation will settle at the 2% target on a sustained basis.

New evidence that suggests this has not emerged over the past six weeks, while the Governor must remain mindful of the hawks’ concerns about easing before inflation really settles at its target level. The recent labour market releases suggest those concerns about inflation persistence are overstated.

The Prime Minister followed up his trip to China with visits to other East Asian countries, most notably Japan.

Prime Minister Sanae Takaichi and Starmer agreed that the two countries will boost their cooperation in the security field, including economic security, during their talks in Tokyo on Saturday. Under the agreement, the countries will work together to strengthen the supply chain for critical minerals and accelerate progress in the trilateral development of next-generation fighter aircraft among Japan, the U.K., and Italy.

The two leaders also agreed to establish the Japan-U.K. Strategic Cyber Partnership, a comprehensive bilateral framework for cooperation in the cyber domain.

Japan-China relations have deteriorated following Takaichi’s remark in the Japanese Parliament over a possible Taiwan contingency. Amid this, Takaichi is believed to have explained Japan’s position to Starmer, hoping to share the same understanding of China's repeated acts of coercion.

Takaichi said at the start of the meeting that cooperation between Japan and Britain “symbolises the inseparability of the security of the Euro-Atlantic and the Indo-Pacific.” Starmer added that the cooperation between the two countries has progressed remarkably in all fields. In a joint news conference after their talks, Starmer revealed that he invited Takaichi to Britain.

Following the Starmers meeting earlier in the week with China’s President, the tariff on exports of whisky will be symbolically cut today. This, Starmer believes, shows that the two nations can carry out agreements quickly.

The pound continues to benefit from the reset of market views on the dollar and the benign neglect of the U.S. Administration. It rallied to a high of 1.3861 last week but ran into some selling pressure and fell back to close at 1.3676.

So, after all the hints and teasers, President Trump has settled on one of his original picks to be his nominee for Chairman of the Federal Reserve. IBM Vice Chairman Gary Cohn said Sunday that Kevin Warsh is "very highly qualified" and will "take the Fed back to its traditional norms.

On Friday, Trump announced that he had nominated Kevin Warsh to serve as the next chair of the Federal Reserve Board, writing on social media that he has "no doubt that he will go down as one of the GREAT Fed Chairmen, maybe the best."

Warsh, 55, served on the Federal Reserve Board of Governors from 2006 to 2011, becoming the youngest member in the board's history. More recently, he's worked with billionaire investor Stanley Druckenmiller and held academic positions, including at the Hoover Institution.

The President's selection of Warsh as his nominee is expected to be seen as a safe choice on Wall Street, given his experience in monetary policy and well-established views on inflation.

Cohn said he expects Warsh to "stay out of a lot of the non-financial issues," while he is "going to be involved, obviously, in setting interest rate policy."

"There is a pressure right now for interest rates to go lower," Cohn said. "I think that he will probably follow through with one or two cuts this year."

Just one day after announcing his nominee for the next chair of the Federal Reserve, President Donald Trump joked that he might sue the nominee if he did not vote to lower interest rates at subsequent FOMC meetings.

The joke was made at a dinner that featured what many characterised as a "bipartisan" audience, including officials from politics, business and the military. Asked about the joke later, Trump told reporters that the dinner had been a "roast" and that he expects Kevin Warsh to be instrumental in lowering rates.

President Trump said Saturday that he expects Warsh to pass the Senate confirmation process easily.

“He’s a very high-quality person. He should have no trouble getting through,” Trump told reporters aboard Air Force One, suggesting Warsh could pick up some Democratic support.

He’s so good that he’ll probably get Democrat votes, commented the President.

Trump announced a day earlier that he was nominating Warsh, a former Federal Reserve board member, to replace Jerome Powell as chairman of the Central Bank when Powell's term ends in May.

The President told reporters that he hoped Warsh would lower interest rates but that he had not received any kind of commitment.

Warsh will likely replace Stephen Miran as a Fed governor before his confirmation.

With Kevin Warsh as his Fed-chair pick, President Donald Trump was hoping that he had put his stamp on the Central Bank and put the current Fed chair, Jerome Powell, in the rearview mirror. But some Fed watchers say that it isn’t that simple and that, by selecting Warsh, Trump may have made it more likely that Powell will continue to stand in Trump’s way.

Powell has the option to stay on the Federal Reserve’s Board of Governors until 2028 after his term as chair ends in May. It would be unusual, but not unprecedented, for him to remain. Now, with Warsh, who has been a fierce critic of the Powell Fed poised to take the helm, Powell may feel motivated to stay to ensure the Fed’s continued independence, amid continued pressure from Trump on the central bank to lower rates.

The dollar recovered from its recent lows following Trump’s announcement. The index had reached a low of 95.56 but rallied strongly to close at 97.13, as investors expressed their satisfaction with the President’s choice.

Germany continued its quest to complete trade deals outside the EU, inking a declaration to intensify energy cooperation with Saudi Arabia during a visit by German Economy Minister Katherina Reiche to Riyadh on Sunday.

Reiche and Saudi Energy Minister Abdulaziz bin Salman also signed 10 letters of intent to expand cooperation between German and Saudi companies. "The agreements cover key areas for the future," said Reiche, naming energy, artificial intelligence, hydrogen, industrial value creation and innovation. She noted a Saudi deficit due to falling oil prices, adding that Riyadh was looking to diversify its revenue sources.

"Diversification is therefore also a way of insuring against fluctuating oil prices, getting unemployment under control and giving the country's younger generation prospects for the future."

The memorandum of understanding agreed between the two countries covers all areas of energy and the chemicals sector. It addresses the handling of the greenhouse gas carbon dioxide, digitalisation in the energy sector and the establishment of reliable supply chains.

Cooperation between companies and the public and private sectors should also be strengthened.

During Reiche's visit, German and Saudi energy companies agreed to export ammonia, as the two countries seek to expand their partnership on green hydrogen.

The eurozone economy posted 1.5% growth in 2025, while the broader EU achieved 1.6% growth, data released Friday by the bloc's statistical office, Eurostat, revealed.

The calculations are based on quarterly, seasonally adjusted, and calendar-adjusted measurements. Economic acceleration slowed as the year ended, with seasonally adjusted GDP in the eurozone and the EU climbing 0.3% quarter-on-quarter in the fourth quarter of 2025.

Year-over-year comparisons showed GDP advancing 1.3% in the euro area and 1.4% in the EU for the October-December period.

Lithuania topped all member states with available fourth-quarter data, recording 1.7% quarterly expansion, trailed by Spain and Portugal at 0.8% apiece. Ireland stood alone in contraction territory, with GDP shrinking 0.6%.

There is a new sense of optimism in the region, based on the ECB having brought inflation under control despite also cutting interest rates significantly. This has been based around a strong Euro, which market practitioners are well aware may not last. Although the Euro has begun the year on the front foot, it is unknown what pitfalls could beset the single currency by the end of 2026.

Last week the Euro traded in a significant range but closed close to where it started at 1.1837.

Have a great day!