21 January 2025: Consumer confidence is still falling

There is growing speculation that Bank of England Governor, Andrew Bailey, is considering favouring a fifty-basis point rate cut at the next meeting of the Bank’s next Monetary Policy Committee.

The meeting will take place on February 6th.

Bailey feels that inflation is unlikely to increase greatly since the causes of its considerable rise in the wake of the pandemic are now well understood and unlikely to be repeated.

The Chancellor is in Davos at the World Economic Forum with one significant purpose: to drum up investment for “UK Inc.”

She will face a tough time despite the country’s clear potential in several sectors currently “en vogue.”

There are concerns that the measures she introduced in the Budget will see employment costs increase to the extent that they will harm investment potential.

The government was right to describe the recent bout of market volatility in the United Kingdom as being fuelled principally by “global factors”, in particular, a sharp rise in US bond yields. Although it is clear from the past couple of weeks that the economy is front and centre when it comes to any disruption caused by increasing bond yields

It was also right in touting how well UK markets have coped with the turmoil. But no one should downplay the added challenges the UK economy will confront in the months ahead, the structural weaknesses that are compounding its vulnerability, or the policy action that is urgently needed.

The International Monetary Fund said on Monday that the UK’s economy is set to grow by 1.6% this year, which is an increase of 0.1% from predictions in October.

The IMF’s chief economist, Pierre-Olivier Gourinchas, said this reflects “continued pick-up in real incomes and consumption,” which comes as the Bank of England is expected to cut interest rates.

“We see some positives coming from increased public spending,” Gourinchas said. “Of course, some of the Budget is financed by increased taxes – national insurance contributions have been increased – that could weigh down, but the net effect in our assessment is still positive for growth for the UK economy in 2025.”

This will provide a boost for the Chancellor Rachel Reeves, who has to date suffered a tumultuous start in No 11.

Any rate cut in the UK is expected to follow the U.S. Federal Reserve “holding fire” on any loosening of monetary policy until President Trump’s plans for fiscal policy become clear, which may see the pound lose ground in the medium term.

However, the pound made significant gains yesterday as the market listened intently to Trump’s inauguration speech. It climbed to a high of 1.2344 and closed at 1.2344 and closed at 1.2388.

Donald Trump was inaugurated as U.S. President for the second time yesterday.

Although people close to him say that he has spent the past four years reflecting on what he did wrong during his first Presidency and how he can improve his inauguration speech was full of the rhetoric the market has come to expect.

The overarching message of his speech was that he intends to “Make America Great Again”, by ushering in a “golden age”.

He has wasted no time in getting started, signing an executive order to free 1,600 people accused of the capitol riots following the last election, which Trump lost to Joe Biden.

In his speech, he said he was declaring a state of emergency at the U.S.’s southern border, which will allow troops to be deployed to increase security.

He continued by telling his audience of previous Presidents, members of Congress and invited guests that he would make the U.S. the envy of the world. Instead of taxing U.S. citizens to make other nations richer, he intends to tax other nations to line the pockets of U.S. citizens.

Recent market movements highlight the profound effect of trade policies on the currency. Headlines about President Trump’s tariff plans caused the U.S. dollar to experience significant fluctuations.

Early reports suggested narrowing tariffs, leading to a brief sell-off in the dollar. However, Trump’s denial of these claims on social media reversed the trend, sending the dollar higher.

Tensions between Trump and Jerome Powell are far from new and were on display for much of 2024. On the campaign trail, Trump regularly weighed in with criticisms of Powell, offering that the president should “have a say” in Fed decisions and that Powell has “got it wrong a lot.”

Nonetheless, Trump is certain to leave Powell in situ until the end of his term in office.

There is still some confusion in the market about the next FOMC meeting, which is taking place next week.

At a Jan. 7 press conference, Trump said “Inflation is still raging, and interest rates are far too high. Meanwhile, last month, Jerome Powell and his colleagues at the Fed lowered forecasts for additional rate cuts this year from four to two.

Trump’s comments on the economy are often contradictory. If inflation is indeed raging, the Fed will not be encouraged to cut the Fed Funds rate.

Although the “official line” is that the Fed intends to cut rates twice this year, a lot will depend on economic performance which will be under heavy scrutiny from the President and his Treasury Secretary Scott Bessent.

There is some consideration being given to the idea that the Fed will be able to cut rates once every quarter throughout 2025 as inflation comes more under control. A lot will also depend on the trend of job creation, which ended 2024 on a high.

Three options are on the table; a fifty-point cut, a twenty-five-point cut and no change. Given the recent rhetoric, a fifty-point cut appears to be out of the running, while the other two options are both being favoured by the market.

The dollar index lost significant ground as speculators cut their positions as the market believed that Trump would be more targeted in his imposition of tariffs on the import of finished goods.

It fell to a low of 107.92 and closed at 108.08.

Perennial ECB hawk Isabel Schnabel showed her most dovish side last week as she told reporters that she feels that the Central Bank has room to cut rates at its upcoming meeting, but it must continue to tread carefully and make its policy decisions meeting by meeting and without any preconceptions.

“We currently see no major risks that could prevent us from reaching our 2% target,” she said in an interview. “If that is the case, we will probably be able to lower interest rates further.”

But she also stressed that “after the steep rate cuts over the last few months, “we are getting closer and closer to the point where we have to have a closer look at whether and to what extent we can still reduce rates.”

The ECB has widely telegraphed another quarter-point reduction at its meeting next week, following four such moves in 2024. With inflation expected to sustainably reach 2% this year, officials’ focus is shifting toward the struggling economy.

Economists and investors see a total easing of 100 basis points in 2025, bringing the deposit rate to 2% from 3%.

Still, uncertainty about the outlook for growth and inflation is elevated, not least because of Donald Trump’s return to the White House.

At the moment there’s little information about Trump’s plans, Schnabel said, leading to very high uncertainty that’s dampening private consumption and investments. This is “poison” for the economy, she said.

However, “we are well on track and expect to return to our 2% inflation target this year,” said Schnabel, who also acknowledged that the ECB could have increased rates sooner when consumer-price growth accelerated in 2022 and 2023.

Following concern that the ECB fell being the curve as inflation rose quickly as stimulus was added immediately after the pandemic took effect, the market is concerned that the ECB is being too timid since it is clear that it expects deflation to reach its target this year, and should be considering fifty point rate cuts to avoid a recession.

The ZEW survey of economic sentiment for both Germany and the wider Eurozone will be published tomorrow. It is expected to add to the belief that in Germany, the economy has bottomed out. The situation in France is still dragging sentiment down, with the Eurozone falling to 16.9 from 17.

The entire market is awaiting President Trump’s inauguration later today to see what he has in store, particularly about the NATO budget and the continuing conflict in Ukraine.

The Euro gave the impression of having also bottomed out last week. However, until the situation concerning tariffs is clarified, it will remain under pressure.

Last week, the common currency fell to a low of 1.0177 but rallied to close higher on the week at 1.0275.

Have a great day!