10 February 2025: Stagflation is coming. It may have arrived already

Stagflation. Such a rare phenomenon that economists cannot measure the point at which it happens. In that respect, it is much like a soft landing in that it is more a matter of perception than fact. However, that is where any similarity ends.

The UK economy is heading for a period in which growth is anaemic at best, while consumer prices stay at their current level or rise marginally.

The Bank of England acted pre-emptively in one respect and reactively in another when it cut the base rate of interest by twenty-five basis points to 4.50%.

Andrew Bailey, the Bank’s Governor, spoke with honesty about the current economic situation, although he did not feel able to mention the word “S”.

It may be that only two members of the committee recognized the signs, and they are eternal dove Swati Dhingra and perhaps surprisingly Catherine Mann, who is not known for her dovish tendencies.

The Bank of England surprised no one by cutting rates by 25 bps. More noteworthy was the dovish tilt of the committee, particularly the switch of Catherine Mann from one of its most hawkish members to one of its most dovish, in her vote for a 50-bps cut.”

A swathe of analysts agreed that the coming few months, in which higher National Insurance and minimum wage costs will take effect for employers, will test the UK’s resilience in its battle against rising inflation.

April is the crunch month for inflation. Many unknown variables are looming, the biggest of which is what impact political changes will have on inflation and the path for rates.

The BoE’s analysis showed that it expects inflation to rise to 3.7% this summer, it is hard to see the Bank of England materially stepping up its pace of easing until it sees how the economy digests the increase in National Insurance in the spring.

Nonetheless, the Bank’s signals suggest there is scope for several more rate cuts this year, given the weak growth outlook, and we can see rates below 3% over the next two years.

British workers are increasingly worried about losing their jobs, and it’s preventing the economy from benefiting from a potential uplift in consumer spending, which will concern the Chancellor, Rachel Reeves.

Both Catherine Mann and Andrew Bailey are scheduled to speak tomorrow. Although Bailey will be unlikely to change the narrative from his speech last Thursday, Mann’s comments will be eagerly awaited as she is asked to explain her considerable volte-face.

Sterling saw significant volatility last week but closed almost where it started the week, ending at 1.2407, just eight points higher.

The market’s seeming lack of interest in the January employment report was entirely justified as the U.S. The Bureau of Labor Statistics published data that showed that the economy produced an uninspiring 143k new jobs last month even though the unemployment rate fell to 4%.

However, there was a lot to unpack in the jobs report. January non-farm payrolls came in below the 175k consensus, but there were 100k of upward revisions to the past two months.

Average hourly earnings rose 0.5% month-on-month, but the average working week dropped to 34.1 hours, matching the lows of the pandemic period. That looks like a pretty solid report and would justify the Federal Reserve holding rates steady for now.

The outlook is uncertain as Trump prepares to shake up economic policymaking by cutting federal jobs, imposing big taxes on foreign goods and deporting millions of undocumented workers. His tariffs and immigration crackdown could push up prices, potentially rekindling the inflation that turned many U.S. voters against President Joe Biden and helped return Trump to the White House.

Trump has changed the point of his attack on imports over the weekend. Instead of targeting individual nations, he has announced tariffs on individual products. He announced a twenty-five per cent tariff on U.S. imports of aluminium.

Trump, speaking to reporters on Air Force One on his way to the NFL Super Bowl in New Orleans, said he will announce the new metals tariffs today.

He also said he would announce reciprocal tariffs on Tuesday or Wednesday, to take effect almost immediately, applying them to all countries and matching the tariff rates levied by each one.

“Very simply, it’s, if they charge us, we charge them,” Trump said of the reciprocal tariff plan.

According to government and American Iron and Steel Institute data, the largest sources of U.S. steel imports are Canada, Brazil and Mexico, followed by South Korea and Vietnam.

By a large margin, hydropower-rich Canada is the largest supplier of primary aluminium metal to the U.S., accounting for 79% of total imports in the first 11 months of 2024.

“Canadian steel and aluminium support key industries in the U.S. from defence, shipbuilding and auto,” Canadian Innovation Minister Francois-Philippe Champagne posted on X.

“We will continue to stand up for Canada, our workers, and our industries.”

Trump also said that while the U.S. government would allow Japan’s Nippon Steel to invest in U.S. Steel, it would not allow this to become a majority stake.

“Tariffs are going to make it very successful again, and I think it has good management,” Trump said of U.S. Steel.

The US economy faces significant risks, including mounting national debt, high interest rates, and declining USD popularity, potentially leading to a full-scale economic crisis, although such an event is not considered likely currently.

Geopolitical tensions, particularly with China and Russia, and the possibility of a BRICS common currency, threaten the USD’s dominance and could trigger investor panic. It seems the rest of the world is not going to “sit back and watch” the U.S. president act with alacrity.

The dollar lost ground last week as the market finally reacted to the less-than-stellar employment report. It reached a low of 107.31 but recovered to close at 108.07.

ECB Economist, Philip Lane, has joined the debate about what will be the “neutral level” for Eurozone interest rates, and what needs to be done to achieve that level.

Lane is among the ECB economists who cast doubt on the importance of the neutral rate, a theoretical level that neither limits nor spurs demand in the economy.

The ECB will likely need to cut interest rates several more times before it reaches the level where it is neither supporting nor restricting, the Bank’s economists have said.

New research has said that the neutral rate is between 1.75% and 2.25%, much as Christine Lagarde said last week. That means that the top of the range would be met following just two more meetings if rates were cut by twenty-five basis points at both.

The midpoint of the forecast is where most economists see interest rates in the Eurozone settling.

Irrespective of this analysis, the Governing Council of the ECB is still paying lip service to the idea that every meeting will consider interest rates based on the most recent data available.

There’s a pretty widespread recognition that the EU is facing a bunch of economic challenges right now. Growth has been slowing and, as in many places, there’s been post-pandemic inflation.

But there are other issues too, including a sense that Europe is falling behind when it comes to key technologies like AI and semiconductors.

There’s also an ongoing energy crisis and the recent threat of tariffs from the US.

It is not necessarily “all sweetness and light” in Spain currently. It recorded a total of 855 bankruptcy proceedings and 4,533 dissolutions in the first month of the year, representing an increase of 34% and 3%, respectively, according to data published this Thursday by Informa D&B.

It is the smaller companies, specifically microenterprises, that account for the majority of the bankruptcies initiated in January, at 81%. Small enterprises make up nearly 17%, medium-sized enterprises account for 2%, and only one large company filed for bankruptcy in January.

Meanwhile, German exports rose in December, while industrial production fell more than expected, reflecting an uncertain outlook for the eurozone’s largest economy.

Exports rose by 2.9% compared to the previous month, data from the Federal Statistical Office showed. For the whole of 2024, exports contracted by 1.0% compared to 2023 due to weak demand from China. Imports fell by 2.8% and the foreign trade balance showed a surplus of 241.2 billion euros in 2024.

Increased competition from abroad, high energy costs, still-high interest rates and an uncertain outlook have weighed on Germany’s economy, which shrank in 2024 for the second year in a row.

In France, the economy continues to be battered by political uncertainty.

The French President hailed the cross-party budget deal as a crucial step in “enabling our country to move forward”, although a cabal of top French business leaders said Mr Bayrou was fiddling while France burns.

They warn that the budget, which they say imposes tax rises on big business and fails to significantly slash state spending, runs the risk of pushing companies to flee France in droves just as America and other countries are going the other way.

The Euro also saw significant volatility last week as it fell to a low of 1.0210, although it later rallied to close at 1.0327.

Have a great day!