20 January 2025: Two rate cuts are the market’s estimate for this year

The same news that has driven the Sterling to its lowest level versus the dollar in a year was responsible for the FTSE100 reaching a record high last week.

There are fears that the economy is stagnating, as the most recent data on GDP saw the economy shrink by 0.1% in November, which may be a prelude to a shallow but damaging recession during the first half of this year.

The government has made no secret of its desire to promote higher levels of growth than has been seen since the end of the pandemic, but those are being thwarted at almost every turn.

The Prime Minister has written to the heads of the UK’s regulatory bodies to ask for suggestions about how they can promote growth. The head of the Financial Conduct Authority has responded with a three-page letter in which he suggests one particular avenue which may be both controversial and risky.

He suggested that the Government should consider relaxing the rules on mortgage lending that were brought in following the 2008 financial crisis.

Lenders have been saying for some time that several of the regulations could be relaxed to allow them to lend to borrowers who do not meet all the (strict) criteria to gain approval, particularly the deposit requirements.

Rachel Reeves appears to have survived the worst of the crisis, which has been partly due to changes delivered in her October Budget and partly due to the turmoil currently affecting global markets. She is unlikely to change her attitude or her behaviour since she is determined not to be undermined by market reaction.

Having returned from China with a “chamberlainesque” agreement on trade which she held up as justification for her trip, she is travelling to the World Economic Forum in Davos today, at which she will further promote the country’s credentials as an investment destination.

Allies are saying she will use spending cuts rather than further tax increases to meet her own fiscal rules.

The news comes with the government backing a package designed to crack down on fraud in the benefits system, with new laws clawing back money wrongfully claimed. Officials say the drive will save £1.5bn over the next five years. Ministers said they had inherited a “broken” welfare system in which fraud and error were costing the taxpayer almost £10bn a year.

There is no time limit on how long an incoming Government can spend blaming its predecessor, but Labour must be coming close to what should be a natural conclusion of the “blame game”.

Unemployment data is due for publication tomorrow, with the unemployment rate expected to “tick up” to 4.4% from 4.3% in November. This is a dataset that will be of particular interest to Bank of England Governor, Andrew Bailey, as he is on record as saying that going forward the economy will be as important as inflation in driving monetary policy.

Last week, the pound saw significant volatility. It fell to its lowest level since October 2023 but recovered to close at 1.2170.

Today is a day that Americans dreaded and looked forward to with excitement in almost equal numbers.

The second term in office of Donald Trump will begin today as he is sworn in as the President of the United States.

While observers are concerned about the rhetoric he has used since winning the November 5th election, several commentators have observed a new, calmer Trump following the assassination attempt he survived during the campaign.

Talk of making Canada the 51st state or taking over both Greenland and the Panama Canal has been typical of his outbursts, while his apparent dislike of both outgoing President Biden and his Vice President Kamala Harris has been swept away by his behind-the-scenes cooperation with both the get the Gaza case fire over the line.

President Joe Biden will leave the White House with a strong economy, historic gains in the job market, a foundation for future manufacturing growth, and having brought down decades-high inflation without triggering a recession. He has relied almost exclusively on Fed Chairman Jerome Powell to achieve the fall in inflation, although a large part of that has been by “natural causes”.

Inflation rose due in large part to the level of stimulus that was pumped into the economy following the pandemic, so Powell’s role was one of timing, which he got just about right despite the “braying” of Wall Street that the delay until September was driving the economy into a recession.

Several members of the FOMC came out of the woodwork last week to pronounce their opinions on the prospects for inflation in 2025. Almost unanimously, they agreed that prices would fall to their 2% target sometime this year.

The entire global financial market will be glued to its collective TV screens later today and for the rest of this month to hear what policies the new President will be unveiling, especially concerning global trade.

Trump has said in the recent past that “tariff” is one of his favourite words. In reality, he is likely to use such a sanction sparingly, and then only to squeeze concessions out of trading partners like China and Mexico.

The FOMC will meet next week and is expected to agree on a twenty-five-basis point cut in the Fed Funds rate. The data that has been released recently, with inflation rising marginally and a strong December jobs report, means that the risks are skewed towards no cut rather than the fifty-point cut that some are hoping for.

The dollar took a breather last week following the substantial gains it had made recently, as traders decided to wait and see the effect of Trump’s first few days in office. The dollar index rose to 110.18 but, given the thin air at that altitude, fell back to close at 109.36.

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!