17 March 2025: The economy shrank last month

On Friday, as she worked towards delivering her spending report to Parliament in the next couple of weeks, Rachel Reeves received the news that the economy not only failed to grow in January, it actually contracted by 0.1%.

This is a metric that is difficult for the Government to avoid, since it is Reeves’ stated aim to grow the economy by whatever means necessary.

Manufacturing and construction output were the two areas that contracted. It is a “stock answer” that any decline in construction output in winter is blamed on the weather, but falling manufacturing output, while easy to explain, is a significant challenge to the Chancellor’s growth strategy.

When questioned, many manufacturing company CFOs blamed the drag on business confidence created by the imminent rise in the national minimum wage and employers’ national insurance contributions.

This has been a drain on businesses' intentions to increase both staffing levels and employee incentives like wage increases and productivity bonuses.

There was better news for the Chancellor in the longer term GDP result. In the three months to January, the economy grew by 0.2% compared to the previous three months.

Monthly services output grew by 0.1% in January 2025, following growth of 0.4% in December 2024, and grew by 0.4% in the three months after January 2025, while production output fell by 0.9% in January 2025, following growth of 0.5% in December 2024, and fell by 0.9% in the three months after January 2025, with manufacturing output driving both the monthly and three-month falls.

Construction output fell by 0.2% in January 2025, following a fall of 0.2% in December 2024, but grew by 0.4% in the three months after January 2025.

The data reveals in stark relief the complete underestimation of the political blunder Reeves made in October when she raised taxes on businesses.

In the spending review, she is expected to cut the welfare budget significantly, with some experts believing that more than five billion pounds in cuts will be made, with several affecting the most vulnerable members of society.

There have been some high profile members of the Cabinet who have raised concerns, Deputy Prime Minister, Angela Rayner and Energy Secretary among those threatening to vote against the proposals. It is likely that in the final document, some of the more radical proposals will be watered down since any rebellion would not cast the Prime Minister in a favourable light ahead of his first electoral challenge since he came to power, with local council elections due to be held in May.

Volatility in the financial markets remained high last week as the pound looked on the verge of challenging the 1.30 level. It actually appeared to “top out” at 1.2945, closing at 1.2927.

The Bank of England’s monetary policy committee will meet later this week and despite the new-found dovishness of one of its previously hawkish members, it is unlikely that they will vote to cut rates given the current global uncertainty.

President Trump would never admit to the White House press corps that his economy is not only not working, but the threat of a recession is little more than a recalibration created by the “big job” that he and his Cabinet have undertaken.

Should the economy take a turn for the worse, some pundits are suggesting, it is hard to imagine Trump being able to change course since he is not one for admitting he was wrong and is heavily committed to his “MAGA” rhetoric.

Some experts believe that he will only impose tariffs on his country’s leading trading partners for a few months, to give them an albeit brief glimpse into the world that can expect if they do not comply with his wishes, primarily around undocumented immigration and illegal drugs.

The European Union and Canada have felt the initial impact of his tit-for-tat measures, with tariffs of 200% on exports of alcohol from the EU to the U.S. in retaliation for the tariff Brussels has imposed on its imports of Bourbon Whiskey from the U.S., while Canada has seen increased tariffs introduced as it retaliated by slapping a 25% tax on electricity exports to the U.S.

China has been more low-key in its reaction to the introduction of tariffs, but is no less serious about its reaction to Trump’s bullying.

The FOMC will meet this week to discuss any change to monetary policy. Trump has already threatened to place a “White House Envoy” on the Committee, since it annoys him intensely that he is shut out from the decision-making process of a large part of the economy.

Even before Trump took office for the second time, the Regional Fed Presidents and Fed Governors who make up the Federal Open Market Committee had been considering what could be a lengthy pause in rate cuts to allow the economy to “catch up” and see the effects of what were certain to be radical economic policies.

Despite the fall in the headline rate of inflation in February, the committee is unlikely to change its collective mind this week, given the uncertainty that Trump has spawned.

Were inflation to have fallen again this month, or the employment data point to a significant slowdown for the economy in the first quarter, it is possible, in fact likely, that a cut would be more seriously considered at the May meeting, which takes place on the 7th of that month.

Jerome Powell will need to tread exceptionally carefully in his press conference on Wednesday. He will need to walk a tightrope in which he will need to express confidence in the continued health of the economy while accepting that should inflation continue to fall, a resumption of the cycle of rate cuts should be possible.

The dollar index experienced what can only be described as a rout last week as the market gave the President the benefit of its views on his economic policy.

It fell to a low of 103.46 and closed at 103.81 as traders no longer saw the Greenback as a safe investment.

Manufacturing output and retail sales data are due to be published today, while later in the week, industrial production and real estate data are due. However, as usual all eyes will be on the White Press room where most economic policy is now formulated.

Is the European Union simply unlucky in the timing of the “disasters that have befallen it since its inception, or is there a malaise running through its institutions which means it cannot react readily and speedily?

The 2008 financial crisis was in small part caused by the indiscipline of several members who were unused to having such low interest rates and mistakenly believed that suddenly they were able to borrow at rates only previously seen by the most creditworthy of nations, like Germany.

Lenders mistakenly believed that the ECB would provide a solid backstop as countries like Greece, Italy and Ireland saw budget deficits balloon and debt to GDP ratios reach previously unimaginable levels.

To its credit, Greece has performed admirably since then, enacting a programme of reforms that have seen the country that was listing very badly right itself.

The Covid pandemic provided the European Commission with an opportunity to show its mettle, but unfortunately, Ursula von der Leyen showed that she wasn’t up to the task, making several errors of judgment.

The ECB allowed too many nations to insist that it continued to support them as they recovered from the pandemic, this led to spiralling inflation, which the Central Bank had to fight by raising rates to a level that had not been seen before to bring prices back under control.

This continued hiking of rates was a significant contributory factor to the slowdown which has led the economy to contract for two successive years.

The Russian invasion of Ukraine led the energy price to spike just as changes were necessary to the region's largest economies like Germany and France to move away from energy-hungry heavy machinery-based industries to more nimble service based ones.

The advent of Trump's second term in office has caused significant upheaval in the financial markets, but has seen the Union open its eyes to the need to strengthen its military capability.

So, what is next? Economists fear another debt crisis as countries borrow more to comply with Trump’s demands that they increase defence spending. This time there will be no statespersonlike figure like Angela Merkel to make the necessary tough decisions.

The economy is showing signs of a recovery, but that could easily be crushed under the heavy pressure being exerted by the global economy and the introduction of tariffs.

The euro has reached “dizzy” heights despite the ECB continually cutting interest rates. At some point, that will end, and the fall towards parity may be swift.

For now, the market is content to be in reactive mode, keeping a very watchful eye on both Washington and Frankfurt.

Last week, the single currency reached a high of 1.0947 but was unable to push on towards the 1.10 level, eventually falling back to close at 1.0878.

Have a great day!