20 February 2025: Inflation hits 3% again

While it had been expected that inflation would have risen in January, the eventual release of the CPI data yesterday was still a surprise to the market.

Headline inflation rose to 3% in January, from 2.5% in December, its highest level for ten months, the core, with volatile items stripped out, also rose by fifty basis points to reach 3.7%.

Adding VAT to private school fees was a significant part of the increase, as was the increase in certain foodstuffs, air travel, and hotel accommodations.

Bank of England Governor Andrew Bailey, who spoke recently about the economy is in a “static state”, told reporters yesterday that the world was experiencing a period of ‘heightened uncertainty’ which could impact global growth.

He went on to say that the UK is experiencing a “weak growth environment” as he cautioned over the impact of “global fragmentation” on the world economy.

Yesterday’s inflation date removed any chance of an early cut in the base rate and rendered inflation hawk Catherine Mann’s change of heart to vote for a fifty-point cut at the last Monetary Policy Committee meeting even more out of character.

There have been significant increases in a whole range of foods over the past year, with lamb, coffee and chocolate all experiencing increases of well over 10%.

The economy is still struggling for growth as the Prime Minister explains to anyone who will listen that no one expected the new Government to cure all the issues created by the former Government in its first six months in power, despite constantly telling the electorate that they are making a major effort to promote growth across the entire economy.

With the inflationary effect of the increase in employers’ National Insurance contributions just around the corner, which is sure to add to inflation, homeowners cannot expect to receive further support from lower mortgage costs any time soon.

The ONS also published data for the housing market yesterday, showing that house prices rose by an average of 4.6% last year.

In December, the average house price in England was £291,000, compared with £208,000 in Wales and £189,000 in Scotland. Meanwhile, provisional data shows average UK rents rose by 8.7% in the year to January 2025. Last month, the average rent for England was £1,375 per month, compared with £780 in Wales and £995 in Scotland.

With inflation rising so aggressively and any growth being seen as “marginal”, the Chancellor is facing a series of major decisions over the next six weeks to avoid the economy from slipping into stagflation.

She will release her spending plans next month, facing the prospect of the economy now being the slowest growing in G7 while it was the fastest growing over the final year of the previous government.

The pound saw a significant rally yesterday as the data drove down any expectations of a rate cut any time soon.

It climbed to a high of 1.2640 but fell back as the dollar rallied as traders feared more risk aversion, which led to further buying of the Greenback.

Jerome Powell will continue to defy President Trump as he believes that GDP growth has been solid over the past six months and is likely to remain that way over the first half of the year, even though the battle to reduce inflation is proving far trickier than expected.

The threat of the imposition of tariffs on the import of a wide range of goods and raw materials from most of America’s trading partners is likely to keep inflation relatively high until the situation calms down and Trump’s true intentions become clear.

Trump has switched his attention to the conflict in Ukraine as he continues to freeze both Ukrainian President Zelenskyy and the European Union out of any peace negotiations. He believes that Zelenskyy had ample opportunity to negotiate a settlement over the past three years as he launched an extraordinary tirade against the Ukrainian President.

In the past few weeks, Trump has completed a complete 180-degree turn from supporting Ukraine militarily to accepting many of Vladimir Putin’s proposals for a peace deal.

However, as is usual with the U.S. President, his outlandish comments may be a smokescreen to cover his genuine intentions. Trump wants access to Ukrainian rare earth and its oil and gas reserves as part of the payment for the number of weapons and other military hardware that his country has supplied.

When Trump switches his attention to another global issue, witnessing how he has not mentioned Gaza for a couple of weeks, the focus on the conflict will cool down.

After three cuts to its key interest rate last year, Federal Reserve officials and their Chairman, Jerome Powell, have signalled that they are in a new phase of watching and waiting.

They’d like to see inflation fall further and gauge what impact the new policies from President Donald Trump, particularly tariffs, will have on the economy before they reduce borrowing costs further.

One of those officials is Austan Goolsbee, President of the Chicago Fed. In an interview with The Associated Press, Goolsbee said that he expects inflation to decline and thinks the job market is stable. If tariffs don’t worsen inflation, rate cuts could resume, he added.

However, that is a “big if” given the level of tariff Trump is expected to levy, although this whole exercise could still be a huge bluff designed to extract concessions that may be unrelated to trade from several of America’s erstwhile partners.

Goolsbee went on to say, “We’ve got solid growth, and we’ve got a stable jobs market, at around full employment. There have been bumps along the way, but looking at the longer term, we have made a lot of progress on inflation toward our target. Of course, we should keep an eye out for overheating. But thus far, this doesn’t look like overheating to me.

If we can clear out the fog coming from these uncertainties in the short run, what lies beneath it is pretty strong.

The dollar reacted to an increase in risk aversion to reach a high of 107.38 as it recovered from the shock of the past two weeks. It closed at 107.19 but could react in any way dependent on the next ad hoc policy decision that Donald Trump makes.

The time has come for the hawks on the ECB’s Governing Council to call for discussions to take place concerning the expected level of interest rate cuts that are expected to be made in the coming months.

Governing Council Member and ECB Board Member Isabel Schnabel, known for her hawkish views on monetary policy and the fight against inflation, has been quiet recently, but no one is treating her silence as agreement with current ECB policy.

Hawkish remarks have now come from European Central Bank policymaker Schnabel, who said that with rates moving away from being restrictive, the Bank needs to now debate when to pause or halt rate cuts.

She is flying the flag for the hawks on the Governing Council. Though this rhetoric suggests that the argument for moving rates notably below neutral has diminished, there are still risks to the euro area, namely U.S. tariffs.

Considering the tariff overhang, the path of least resistance continues to favour additional rate cuts, particularly because the ECB has room for another 50bps of cuts until the top of the estimated neutral rate range, 1.75-2.25%, is reached. At this point, the ECB may begin to look at slowing the pace of easing.

While a March cut looks to be a fait accompli given market pricing, there is a little more uncertainty over an April cut, currently priced at 53%, even as the market considers that every meeting until July will vote for a rate cut. It may be unwise for rates to be cut below what is considered to be the neutral rate, given that inflation is far from defeated.

Schnable appears to be misguided in considering her opinions to be ECB “policy”. With rate expectations still favouring further cuts, to say that the Bank is “nearing” the point when it will pause rate cuts is little more than wishful thinking, even if she does feel she has the power to change Council minds.

Germany was the unchallenged engine behind Eurozone growth and productivity until its outmoded industrial model fell foul of Chinese gains in both quality and efficiency. It has gone from engine to deadweight as the EU tries to move on and challenge different markets where it may find a more level playing field.

Following this weekend’s election, the incoming chancellor will inherit a host of problems buffeting German industry, including high energy and labour costs along with a looming trade war.

The automotive industry fuelled Germany’s rise as Europe’s economic powerhouse. Now, that same sector is in crisis and is taking the country down with it.

Carmakers are facing a perfect storm: a shift from the combustion engine, which highlighted German engineering, to less complex electric vehicles where Germany doesn’t control crucial battery technology.

They are also battling slumping demand for electric vehicles in Europe, high energy and labour costs, a collapse of sales in their key market of China, and the arrival of aggressive Chinese rivals on the continent.

The prospects for the Euro are particularly bleak, with growth across the region anaemic while the ECB continues to loosen monetary policy.

Yesterday, the single currency lost ground for the third consecutive session. It fell to a low of 1.0401 and closed at 1.0425.

Have a great day!