7 July 2025: Where will interest rates eventually settle?

The first question that needs to be asked following last week’s massive climbdown by the Government over the Welfare Reform Bill is “who is now running the country?” Does Keir Starmer have control over policy any more, or are his plans subject to the approval of his Party’s backbenchers?

A senior politician was quoted last week as saying that Governments without unity do not last long. Last week saw the most striking example of disunity that has been witnessed in Parliament for fifty years.

Rachel Reeves’ plans to have no unfunded commitments are now in tatters. Tax rises this Autumn are now certain as she battles with a black hole in the economy of her party’s own making.

Professor Alan Taylor, the newest independent member of the Bank of England’s Monetary Policy Committee, has called for the equivalent of one hundred basis points of interest rate cuts to take place during the second half of this year.

It is unclear if he believes that will be sufficient to drive growth in the economy, which has been sluggish at best so far in the first two quarters.

Taylor, one of two Monetary Policy Committee members to call for a larger 0.5 percentage point cut last month, said that while he would not predict his future votes, he believed that one-off factors were influencing recent economic data.

The latest figures show that UK inflation jumped by more than expected in April, to 3.5% from 2.6% in March,1.5% higher than the Bank of England’s 2% target.

However, much of that rise reflected a jump in water bills, energy costs and council tax. “Higher inflation is not coming from demand and supply pressures; for the most part, it’s coming out of one-time tax and administered price changes,” Taylor said, adding that energy prices had otherwise been trending downwards.

“The BoE forecast path is saying there is going to be an inflation hump, and then it’s going to go away,” he said

He believes that the “hump” will not be affected by the one-off items that have driven inflation higher recently, since they will disappear “naturally”.

The next meeting of the MPC is due to be held on August 7th, and if Taylor is correct, inflation should have fallen back appreciably closer to the Bank’s target by then, and he will again vote for a 50bp cut.

The formation of yet another political Party in the UK could see Labour's support divided in the future. It is projected that the as-yet-unnamed hard-left party could take as much as 10% of Labour's support, leaving it trailing even further behind Reform UK and tied with the Conservatives, which have suffered a similar fate.

The pound is looking technically ready for further downside movement according to the latest charts. Last week, it fell to a low of 1.3562 but recovered to close at 1.3651.

The muted reaction by Iran so far to the attempted destruction of its nuclear capability is beginning to cause concerns in Washington about what they may be planning.

It seems that they are unable to make any impression on the American military presence in the region, as their attempted attack on U.S. military bases in Qatar showed recently.

It may be that they are about to return to “Guerrilla” tactics that have served them well in the past. A concern that military and industrial specialists have is that the pace at which technology is advancing may leave back doors in their systems through which untold damage could be done to U.S. infrastructure, both at home and abroad.

Not only would this allow Iran to have plausible deniability, but it would inflict far greater damage than it could if acting purely militarily.

The JPMorgan Chase CEO, Jamie Dimon, is looking for ways to improve his ability to predict the future of the U.S. economy, which has been spectacularly wrong in the first six months of the year.

At the weekend, appearing on TV, he said that he believes that the size of U.S. Government debt, which is now close to reaching 100% of GDP, could “blow up in the face” of the current administration.

With Government debt reaching $36.2 trillion, the dollar’s global reserve crown could be beginning to slip. The U.S. has slipped into a similar issue, which faces families with a strong credit rating which hit a “tough patch”.

They begin to borrow to finance day-to-day expenditures, believing that when the good times return, they will be able to reverse any damage, but the longer the “rough patch” continues, the worse their credit rating becomes, and interest payments begin to spiral out of control.

Project this on a national scale and one day the U.S. will lose its AAA rating and China will begin to demand higher interest rates to fund the economy and the relationship between the two countries where China effectively lends the U.S. money to buy its goods will become irrelevant since the U.S. will be paying more in interest that it does to run its economy.

Trump’s agenda should be far more about cutting government debt than aggravating its neighbours by placing tariffs on their exports to the U.S.

Yet again, Jerome Powell has been proven correct in his desire to wait and see where inflation is headed before cutting interest rates. With 147k new jobs created in June, the Fed will still see no urgency to cut interest rates.

The dollar lost value again last week, but at least the pace of its decline appears to be slowing. With the deadline happening this Wednesday for the end of the temporary halt to tariffs on U.S. imports, there may be further volatility no matter which way the President jumps.

The index fell to a low of 96.38 last week but recovered to close at 96.97.

Finally, an official of the ECB has agreed that a great deal (if now most) of the success in bringing inflation down has been due to the unusual strength of the Euro during the first six months of the year.

Francois Villeroy de Galhau, the Governor of the Banque de France and a member of the European Central Bank’s Governing Council, believes that the current strength of the Euro may be a contributory factor in inflation in the region, undershooting its 2% target.

He and his colleagues on the Governing Council are watching exchange rate volatility closely.

De Galhau went on to say that he does not see any inflationary consequences from the imposition of tariffs on Eurozone exports to the U.S. He, unfortunately, is blinded by the same obsession as many of his colleagues: that inflation is the “only game in town.”

He believes that the ECB is currently in a good position on rates and inflation. However, if the Euro were to lose 50% of its current strength in the next three to six months, the position by year-end could be completely different.

The eurozone economy has not been “turbocharged” by the reduction of interest rates by 200 basis points over the past year, since the exchange rate and interest rate cuts have cancelled themselves out, leaving the economy still in the doldrums.

A feature of the data that was published by Eurostat during the second quarter was that it was “cautiously optimistic”. However, at some point, that optimism is going to have to turn into growth in the here and now. When officials are confronted with this, they, almost invariably, rely on the fact that Germany has created a €150 billion growth fund that will drive the economy forward in 2026.

What of the economies of France, Spain and Italy? The former is close to being stagnant, while the latter two are still congratulating themselves on their spectacular recovery from the pandemic, which has simply brought them back to where they were before.

Before the region can consider itself truly out of the woods, it needs to consider what will be successful going forward and drop its complete domination by inflation.

The Euro is already showing signs of fatigue. Last week, it made another new high of 1.1830 before falling back to close at 1.1774. The closer it gets to 1.20, the further away the landmark appears.

Have a great day!