4 February 2025: Reeves reviews the tax status of U.S. Tech firms as a trade war looms

4 February 2025: Reeves reviews the tax status of U.S. Tech firms as a trade war looms

Highlights

  • Water, water everywhere, but not enough to build homes
  • Trump wields his power, but risks derailing the economy
  • Inflation rose unexpectedly in January
GBP – Market Commentary

EY downgrades its forecast for the UK economy

Donald Trump has said he is likely to impose tariffs on UK exports to the U.S. even though the country’s exports do not threaten manufacturing jobs in America. The number of products like consumer goods and vehicles exported to the U.S. is tiny compared to both China and the European Union, and Trump believes that a trade agreement is possible.

He will likely threaten to impose a tariff on the UK export of expertise in the pharmaceutical and life sciences sectors to give his country some leverage in negotiations.

It is believed that Rachel Reeves is examining the tax status of the giant U.S.-owned tech firms. The Chancellor will this year reassess the digital services tax (DST), which risks becoming a flashpoint as Britain tries to avoid being slapped with tariffs by the US president.

Ahead of the review, Ms Reeves is expected to face intense pressure from the White House and companies potentially affected by the tax, including the likes of Apple, Amazon and Google.

Trump has already said that duties on imports from the EU will “definitely happen”, while also warning that the UK is “out of line” on trade, although just what that means is unclear, but he has also said that he believes a deal can be done.

The Treasury has instructed Government departments to prepare for potential budget freezes as part of a major spending review scheduled for June, despite Labour’s earlier promises to avoid austerity measures.

Departments are now submitting funding bids for 2026 to 2029, with unprotected areas such as justice, culture, trade and local Government facing the prospect of significant cuts amid pressure from high borrowing costs and stagnant economic growth.

While “unprotected” departments face cuts, Chancellor Rachel Reeves allocated the majority of a 50-billion-pound spending increase for 2028-29 to protected areas. Health, education and defence budgets remain ring-fenced from potential reductions.

In a country that appears to be having more than its fair share of storms and flooding, it is ironic that research published yesterday says that the Government’s ambitious house-building plans could be hampered by a lack of available water, particularly in the East and South East of England.

A lack of water capacity in these regions means that housebuilders may struggle to get approval for development projects. The figures cited in the research account for almost 40% of the added housing required annually in those regions under the Government’s housing targets.

The Bank of England may now be considering a rate cut when its Monetary Policy Committee meets on Thursday. There are rumours that the lower-than-expected inflation figure for December may have tipped the balance.

A cut in the base rate would be a welcome diversion for the Government, which seems to be being stymied at every turn in its efforts to stimulate growth.

A weaker-than-expected end to 2024 means that UK economic growth in 2025 will be slower than previously predicted, according to the EY ITEM Club’s Winter Forecast.

However, the forecast still expects steady quarter-on-quarter growth this year, as interest rates are gradually cut, and increased consumer confidence leads to greater levels of household spending.

The Club has downgraded its GDP growth expectations for 2025 to 1%, down from the 1.5% predicted in October’s Autumn Forecast, reflecting the stagnation in growth the economy experienced in the second half of 2024. This represents only a marginal improvement on the 0.8% GDP growth the UK economy likely achieved in 2024.

Sterling outperformed its major peers, except safe-haven assets such as the dollar and Japanese Yen, yesterday as investors became confident that the UK won’t face hefty tariffs on trade with the United States (US). It reached a high of 1.2436 on a volatile day and closed at 1.2402.

USD – Market Commentary

Canada and Mexico’s tariffs paused for a month

President Trump is brandishing the U.S. economy like a weapon, threatening to put more than a trillion dollars of trade on the line with economic wars on multiple fronts.

The world’s “great consumer” will now decide on the amount it pays for imports from its main trading partners, although the tariffs he has already imposed on China won’t go unchallenged. The tariffs on imports from Mexico and Canada have been paused for a month.

After last-minute calls with Trump, Canadian Prime Minister Justin Trudeau agreed to reinforce his country’s border with the US to clamp down on migration and the flow of the deadly drug fentanyl.

Earlier, Trump made a deal with Mexican President Claudia Sheinbaum. She agreed to reinforce the northern border with troops. In return, the US would limit the flow of guns into Mexico.

Barely three weeks into Donald Trump’s second term, one thing is certain about US trade policy. It is being made by Mr. Trump on a whim, without consistency as to its goals or coherence as to its execution.

This does not bode well for the US and world economies, which do not function well in economic policy uncertainty. It also does not bode well for America’s reputation as a country that can be trusted to stick to its agreements.

A US tariff of 10% on Chinese imports is still due to go into effect from 00:01 EST (05:00 GMT) today. This is because China does not see itself “kowtowing” to the U.S. to buy its goods which it believes are being sold due to the “export” of manufacturing capacity by the U.S. since it cannot compete on price and more recently quality.

The Trump administration’s plans for trade tariffs come with inflation risks, three Federal Reserve officials warned on Monday, with one arguing that uncertainty over the outlook for prices calls for slower interest-rate cuts than otherwise.

While the President is raising the stakes in what feels like a global trading game by imposing tariffs with potentially inflationary consequences for his economy, he is at the same time berating the Federal Reserve for the high level of interest rates, which he describes as restrictive.

“The kind of broad-based tariffs that were announced over the weekend, one would expect to have an impact on prices,” Boston Fed President Susan Collins said in an interview with CNBC, adding that “with broad-based tariffs, you actually would not only see increases in prices of final goods but also several intermediate goods.”

Global asset markets suffered what bordered on turmoil yesterday, while the on-and-off-again tariffs on Canadian and Mexican goods whipsawed the dollar index.

It opened significantly higher at 109.60 since it first seemed that the tariffs would be imposed, then gradually lost ground as the situation developed, reaching a low of 108.34 and closing at 108.40.

EUR – Market Commentary

The French economy appears to be in freefall

Inflation in the eurozone rose unexpectedly to 2.5%in January, compared to 2.4% in December, according to figures from Eurostat. At the same time, the European economy is confronted with new trade threats from the United States.

Core inflation, which excludes volatile components such as energy and food, remained at 2.7%, higher than was hoped for by ECB officials. Although the price increases in the service sector decreased lightly, stubborn inflation indicators continue to challenge the ECB policymakers.

The ECB’s Chief Economist, Philip Lane, has constantly bemoaned the level of services inflation, believing it to be the main reason that rate cuts wouldn’t be more aggressive. Now, as inflation in that sector begins to fall, primarily as wage settlements have moderated, the region is faced with a rise in overall inflation.

The figures follow earlier reports from the largest economies of the eurozone. In Germany and France, inflation remained stable, while Italy and Spain saw an acceleration. This emphasizes that, despite the expectation that inflation this year will fall towards the 2% target, price pressures in some countries remain.

While sustained inflation is not welcome, the figures are in line with the narrative outlined by ECB President Christine Lagarde, who last week said that price growth could oscillate around these levels for the coming months before a slowdown towards the 2% target in later quarters of the year.

The decline in Germany’s manufacturing sector eased in January, helped by the slowest fall in both output and new orders in months, a survey showed on Monday.

The HCOB Germany Manufacturing Purchasing Managers’ Index (PMI), compiled by S&P Global, rose to 45.0 in January from 42.5 in December, marking the highest reading since May last year.

The final reading is nearly a point higher than the preliminary figure of 44.1 but remains firmly below the 50-point mark that separates growth from contraction.

Production contracted at the slowest rate in eight months, while new orders saw the lowest fall since last May, the survey showed. Export sales also declined, reflecting challenges in foreign markets, but at a slower pace. While the data may show that the economy is no longer in freefall, it will not be welcomed by politicians who will fight an election later this month.

Whoever takes control will face a tough job in trying to turn around an economy which is the weakest in Europe.

German manufacturers continued to cut jobs, extending the current period of workforce reduction to 19 months. The pace of job losses, however, was the slowest since August.

France may soon take over the mantle of being the weakest economy in the Union. The data released yesterday showed that the country is facing a precipice which it appears unable to step back from.

The economic situation in France has taken a worrying turn as the nation closes out 2024 with indicators showing instability driven predominantly by political unrest.

The economy experienced a contraction of 0.1% of its Gross Domestic Product (GDP) during the fourth quarter, compounding worries amid rising public deficit levels, which have now reached 6% of GDP.

This positions France as one of the worst performers within the eurozone, reflecting broader concerns about the country’s financial health.

The Euro also experienced considerable volatility yesterday as it traded in a range between 1.0363 and 1.0210 as the threat of tariffs hangs like a dark cloud over the region. It eventually closed at 1.0295.

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Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.