3 February 2025: Rates are on hold as the economy is “chronically weak”

This week’s meeting of the Bank of England’s Monetary Policy Committee is expected to leave the base rate unchanged, despite the economy being described as “chronically weak”.

The country has several structural issues that are ingrained. One of the major issues is the pay increases given to public service workers that are not tied to improvements in productivity. For example, paying train drivers more, without any assurance of better service, that the current malaise continues.

The public sector is a dominant feature of the UK’s economy, despite not adding significantly to the country’s growth and wealth.

Manufacturing output has been falling for a considerable time. It is now stagnating, although the country is at the forefront of life sciences, a sector with one eye firmly on the future.

Andrew Haldane, the former Chief Economist at the Bank of England and adviser to Jeremy Hunt when he was chancellor of the Exchequer, believes that the current Chancellor’s “drive for growth is unlikely to succeed primarily because although she is almost continuously announcing new initiatives, she does not have either the drive or backing to galvanize the country to “go on the journey with her.”

The new projects she announced all have exceptionally long lead-in dates, and any change in the perceived impression of the economy will have to be taken on trust. This commodity is in short supply currently.

Haldane said that to deliver the growth the Government seeks, it should also support older people to work longer and focus on investing in projects outside the major cities.

He also added that Reeves’ doom-mongering, with a focus on the disputed £22 billion black hole in the nation’s public finances, is “among the reasons why we snuffed out the growth in the first half of 2024 and we flatlined it in the second half”.

“Gloomy narratives… were very damaging for business confidence”. He added that sentiment is “more pessimistic than it needs to be.”

Reeves promised to go “further and faster” compared with previous governments in her speech in Oxfordshire earlier this week, after years of sluggish growth in the UK. However, the country needs to “feel better about itself now”.

“After reaching fifty, the employment rate starts falling rapidly, even though people are living longer lives than ever.”

“Provided we live healthily and productively, and continue upskilling, this puzzle resolves by having people remain in the workplace for longer.”

“That would deliver a huge benefit to the public purse and growth. Ageing need not be a problem. It could be the opportunity of our lifetimes if we seize it.”

The Government has so far been reluctant to change the triple lock safety net for pensioners, after a furious backlash to the decision to means-test the winter fuel allowance.

The Pre-emptive cut in the base rate called for by two independent members of the MPC is unlikely to be realized this week. Although a rate cut is still possible, the recent rise in inflation is unlikely to drive the rest of the MPC to cut rates.

Last week, Sterling returned to its downward path as the market fears over the introduction of tariffs by the U.S. were realized. Although the tariffs on Canada and Mexico do not directly impact the UK, the fear that Trump will consider them to be a sufficient tool to bend other nations to America’s will is enough to see the dollar rise.

The pound fell to a low of 1.2250 and closed at 1.2257.

This week, data for house prices and economic output is due for publication, but the Bank of England decision will be the market’s primary driver.

President Trump has followed through on his threat to impose tariffs on his country’s imports of finished goods from some of its largest trading partners. The imposition of tariffs of twenty-five per cent on Mexico and Canada and ten per cent on China is considered a blunt instrument with which to beat them into submission on unrelated issues.

Trump believes that undocumented immigration from Mexico and the flow of illegal drugs from both China and Canada can be halted by his actions. Trump posted on social media that the tariffs were necessary “to protect Americans,” urging the three nations to take stronger measures to curb the manufacture and export of illicit fentanyl. He also called on Canada and Mexico to take further action to reduce illegal immigration into the U.S.

If sustained, these tariffs could significantly worsen inflation, potentially undermining the trust many voters placed in Trump to lower the costs of groceries, fuel, housing, automobiles, and other goods, as he had promised.

Many economists are generally sceptical of tariffs, considering them a mostly inefficient way for governments to raise money and promote prosperity.

Tariffs hurt foreign countries by making their products pricier and harder to sell abroad. Foreign companies might have to cut prices and sacrifice profits to offset the tariffs and try to maintain their market share in the United States. An economist at Shanghai University concluded in a study that Trump’s tariffs on Chinese goods inflicted more than three times as much damage to the Chinese economy as they did to the U.S. economy.

China has not commented yet on the imposition of tariffs, although it has likely already formulated its reaction.

Chicago Federal Reserve President Austan Goolsbee said inflation data released on Friday was a bit better than expected and gives him comfort that inflation is on course to its 2% target, adding that he still expects the U.S. central bank’s policy rate to be “a fair bit” lower in 12 to 18 months.

Goolsbee told CNBC, however, that “there is a question mark that is coming from policy uncertainty,” including over the impact of tariffs that President Donald Trump has imposed on trading partners like Mexico and Canada. “If it affects prices, it affects us, our signal is getting a little muddied when things are happening that drive up prices.”

Fed Governor Michelle Bowman continued Goolsbee’s theme, voicing an underlying faith that inflation is likely to continue to decline this year and allow further rate cuts, even if the timing is uncertain.

The dollar rallied on Friday, adding to its Gans last week as it became clear that the imposition of tariffs was going to happen.

The dollar index climbed to a high of 108.50 reversing its losses in the previous week. It eventually closed at 108.40.

ECB President Christine Lagarde stated on Thursday that the eurozone economy is expected to remain weak in the near term, following a period of stagnation in the fourth quarter of 2024.

She attributed this sluggishness to fragile consumer confidence in the European Union, noting that households have not yet been encouraged enough by rising real incomes to significantly boost their spending.

This cautious outlook highlights the ongoing challenges facing the region’s economy as it works to recover.

Lagarde also discussed the ECB’s decision to lower the deposit facility rate by 25 basis points, explaining that it was made after an updated assessment of inflation trends, underlying inflation dynamics, and the transmission effects of monetary policy.

She emphasized that the disinflation process is progressing well, with inflation continuing to align broadly with the bank’s projections. The ECB now expects inflation to reach its medium-term target of 2 per cent by the end of the year.

Dutch Central Bank Governor Klaas Knot believes that the market’s perception of the next ECB meeting, taking place in March, is correct with another cut “highly likely, although he prefers not to speculate any further into the future,

Knot, a member of the ECB’s Governing Council also commented on the prospect of President Trump imposing tariffs on EU exports.

He expects new tariffs will lead to higher inflation and interest rates in the United States, which will likely weaken the euro.

He said in an interview on Dutch television that trade wars harm all sides, and the best reaction to tariffs in economic terms is to do nothing, but that he expects countries will retaliate out of political considerations.

“Europe will not be pushed around. We are also a powerful trade bloc with 400 million consumers,” he said.

Knot said it was inevitable that U.S. prices would rise due to such tariffs, leading to higher prices for U.S. consumers, and higher interest rates to control the resulting inflation.

“We’re already seeing that reflected in long-term interest rates,” he said. “Some of that will spill over into Europe.”

Knot said he had endorsed the ECB’s rate cut earlier this week, believing inflation in Europe is headed back toward the Central Bank’s 2% target.

The Euro suffered further weakness last week, falling to a low of 1.0210 and closing at 1.0236.

This week will see the publication of activity data for several countries individually as well as the entire Eurozone, it is expected that the headline number will illustrate the importance of further cuts in interest rates.

Have a great day!