13 February 2025: Speculative optimism about the economy is growing

The National Institute for Economic and Social Research gave the Chancellor a welcome boost yesterday as it predicted that the positive measures announced in the Budget will see the economy grow by 1.5%.

This is significantly higher than virtually any other predictions that have been made for 2025.

Naturally, the forecast came with certain caveats about the effect of the tariffs President Trump has threatened to impose on America’s largest trading partners.

The NIESR, the oldest and one of Britain’s most respected think tanks, believes that Sterling will fall in value as the U.S. measures begin to bite.

A separate survey by the British Chambers of Commerce (BCC) found that 63% of manufacturers exporting to the US expected to be affected by US tariffs, while 34% of all UK businesses polled feared some kind of hit.

In a snapshot of the industry after Trump’s announcements, firms reported being concerned about the direct cost of tariffs and the wider effect on the global demand for their products.

William Bain, head of trade policy at the BCC, said: “We have entered a new global era when it comes to tariffs after a prolonged period where trade liberalisation has been the watchword.

There is still a lot of uncertainty around what will happen, especially as the US approach appears to have both trade and geopolitical aims. “The announcement of steel tariffs shows how quickly the landscape can change.”

NIESR said the increase in inflation from trade tariffs would restrict global economic growth this year to 3.2%, the same as in 2024 and to 3.1% in 2026.

In the UK, the pressure on prices from US tariffs would be added to increased government spending, which NIESR said would prevent the Bank of England from making steep cuts to the cost of borrowing.

This point was perfectly illustrated by MPC member Catherine Mann’s change of mind concerning interest rate cuts. She had been expected to vote for no change in rates at last week’s meeting but shocked commentators by voting for a fifty-basis-point cut. If inflation begins to pick up again, she may well change her view again.

“If domestic and international inflationary pressures intensify, driven by budget measures and higher tariff-related costs respectively, interest rates will need to remain higher for longer. This would dampen prospects for economic growth by slowing down business, investment, and consumer spending,” it said.

Interest rates will fall only once more in 2025, to 4.25%, and then settle at 4% next year, according to NIESR’s quarterly health check, dashing the hopes of businesses and households looking for lower borrowing costs.

The NIESR’s forecast jars with the majority opinion of City analysts, who see two rate cuts this year. The outlook for the economy in 2025 is “messy”, with several moving parts that could derail opinion.

The pound experienced a volatile day yesterday but ended up pretty much where it started.

It traded between 1.2483 and 1.2377 but closed unchanged at 1.2445

The price of eggs has been headline news in the U.S. recently, but prices, in general, stirred the markets yesterday as the headline rate of consumer inflation returned to the 3% level.

Many commonly purchased goods and services got more expensive in January, driving inflation in the wrong direction and to its highest rate since June of last year.

Consumer prices rose 0.5% from December, the fastest pace since August 2023, resulting in an annual inflation rate of 3% for the 12 months that ended in January, according to the latest Consumer Price Index data released Wednesday by the Bureau of Labor Statistics.

Economists were predicting Wednesday’s report to be unexciting, with barely any change from December’s data.

Instead, the January report came in higher across the board, an unwelcome surprise at a time when the cost of living continues to weigh on Americans, the Federal Reserve wants to see inflation slow, and uncertainty is brewing as to how President Donald Trump’s heavy-handed tariffs and other policies could affect prices.

The long nightmare of inflation is not over yet for consumers, businesses, and investors in a blow to mortgagees, small businesses, and asset markets.

With the threat of inflationary tariffs being held over the economy like the sword of Damocles, there are choppy waters ahead for the Federal Reserve. Its Chair, Jerome Powell, in his semi-annual testimony before Congress, found out that he may be the only person in Washington with support from both sides of the aisle, although it is his relationship with the President that will drive sentiment.

Senators and Congresspeople urged Powell to ignore the administration and fight “tooth and nail” for Fed independence. Trump demands total control of every part of the economy for his plans to work. The politicisation of the Central Bank would set a dangerous precedent.

The U.S. faces little chance of a recession or resurging inflation in the short run; the Fed is aware of the risks. But it could face a mild form of stagflation. If inflation remains at or around 3% while growth remains as expected, or even a little lower, the market may be concerned that Trump’s policies are not the economic miracle which he believes they are.

What’s raising the anxiety among economists and businesses is the uncertainty spawned by the Trump White House.

The on-again, off-again tariff threats make it harder for businesses to invest, for one thing. They can’t finalise plans until they know how much it’s going to cost to obtain supplies, many of them imported from other countries.

The dollar index also saw increased volatility as traders took a “risk off” attitude to the tariff question, while the inflation data may limit the FOMC’s ability to cut rates.

The index climbed to a high of 108.52 but drifted back to close marginally higher at 108.01.

ECB Board and Governing Council Member Isabel Schnabel has been something of a European version of Catherine Mann over the past eighteen months, and while she has moderated her tone regarding interest rates recently, no one is expecting her to begin to vote in favour of “jumbo” rate cuts.

However, she is becoming significantly more liberal in her views, yesterday commenting that rate cuts alone will not solve the European Union’s structural issues.

Speaking at the German Institute for Employment Research, Schnabel said growth is currently only moderate, while uncertainty over trade has increased “dramatically,” with looser monetary policy offering limited assistance.

“Interest-rate cuts can mitigate the economic weakness,” she said Tuesday in Nuremberg. “But they can’t solve the structural crisis” that includes high energy prices, a loss of competitiveness and labour shortages.

The ECB has been lowering rates since June as inflation recedes toward 2% and the economy falters. Schnabel warned late last year against cutting too far in a bid to tackle issues that fall beyond the remit of monetary policy.

Former ECB head Mario Draghi has proposed ways to perk up Europe’s economy in a wide-ranging report. The European Commission presented its so-called Competitiveness Compass in January, aiming at implementing many of those recommendations.

Schnabel agrees with Draghi that Europe needs to structurally reform its economy, particularly after the return of Donald Trump. and his fondness for tariffs.

“The export-led growth model needs to be reconsidered in the face of this increasing geopolitical fragmentation,” she said.

Europe has a captive audience of more than four hundred and fifty million and has never taken advantage of that fact either in intra-state trade or manufacturing.

That will have to change if it is to be able to challenge Trump’s hegemony and emerge from its latest slump.

The ECB should ease policy gradually and not target a difficult-to-define “neutral” interest rate, Bundesbank President Joachim Nagel said on Wednesday, although it needs to be ready to fight for Europe if a global trade war erupts.

The ECB has cut interest rates five times since last June and hinted at even more in the coming months as the economy ails, fuelling speculation about how far it might cut its 2.75% benchmark rate.

Economists see the neutral rate, which neither stimulates nor slows growth, as a Goldilocks stance. The ECB published a research paper last week showing that the level could be around 1.75% to 2.25%.

But Nagel, like many of his colleagues, played down neutral, also called “r-star” in central bank-speak, arguing that it was not particularly useful given the uncertainty over its exact level.

“The closer we get to the neutral rate, the more appropriate it becomes to take a gradual approach,” Nagel said in a speech in London. “The limits of the concept are also clear: it would be risky to base decisions mainly on r-star estimates.”

Nagel added that the Bundesbank’s estimate for the neutral rate was unsurprisingly a little higher than the markets, between 1.8% and 2.5%, a band so wide that the next cut could already take the ECB to neutral, or it could still be several steps away.

The euro rallied to the top of its recent range yesterday as the market expected global trading nations not to allow President Trump to have his way in changing global trade.

It climbed to the top of its recent range, reaching 1.0428, but fell back to close, as did the entire market close to where it started at 1.0391.

Have a great day!