24 February 2025: An increase in Defence spending would help Reeves

The Prime Minister will visit Washington this week to meet with an increasingly unpredictable U.S. President, with the stinging criticism from Trump about his lack of action to bring the conflict in Ukraine ringing in his ears.

Starmer sees himself and British diplomacy as a bridge between Europe and the U.S., but Trump may see things differently.

From his comments last week, it is obvious that Trump sees Starmer as an earnest person but an ineffectual leader.

The meeting between U.S. and Russian diplomats in Riyadh last week could mark a turning point in the relationship between Starmer and Trump. Starmer will travel to Washington in the hope that he will be able to make a worthwhile contribution to Trump’s foreign policy initiatives, but it is increasingly likely that he will return empty-handed.

For British consumers still reeling from Labour’s first budget, the watchword is caution. Headline inflation has reached 3% again, its highest level in ten months.

Pessimism is rife and households are looking to cut their expenses, for example by eating in rather than dining out, figures last week showed.

Inflation is resurgent and fear of job losses is slowly mounting. Gone too are the so-called excess savings built up during the pandemic, which provided a degree of comfort during the past eighteen months as inflation once again became a major issue.

It’s an increasingly bleak picture for the Prime Minister and his cabinet colleagues, who swept to power in July promising to raise living standards.

Instead, the economy is smaller on a per-capita basis and Labour is sliding in opinion polls.

There is increasing concern at the Bank of England, where two policymakers this month called for interest rates to be slashed by a bumper half percentage point.

The Chancellor of the Exchequer is facing another dilemma as she faces publishing her spending review before the end of next month. The amount the Treasury has borrowed is around eight billion pounds more than the Office for Budget Responsibility had estimated from Fiscal 2024 and to comply with her self-imposed rules, Rachel Reeves will need to either increase taxation or reduce public spending by the Ministries that are not currently ringfenced.

In cutting the base rate recently, the Bank of England has provided some relief to homeowners, but the inflation data will have set them back on their heels since the cut is expected to be the last they see for a considerable time. Some analysts predict that the Bank will not be in a position to cut rates again this year.

This week will be quiet as far as UK data releases are concerned as traders digest last week’s employment and inflation numbers. However, given the volatility caused on an almost daily basis by the U.S. President, traders are expected to have plenty of events to pique their interest.

Last week, the pound benefitted from the expectation that any further cut in interest rates would be a long time coming. It reached a high against the dollar of 1.2678 and closed at 1.2630, while versus the Euro, it reached 1.2100 and closed at 1.2074.

No one can say that in the first couple of months of Trump’s return to the White House, he has not “hit the ground running”. In his own mind at least, he has solved the Gaza crisis, and brought the conflict in Ukraine to the verge of a ceasefire while bringing both Canada and Mexico into line, limiting undocumented immigration and the flow of illicit drugs.

He has yet to set his aim on the European Union, which he regards as a “talking shop” with little decisive action being taken about internal or external politics.

Last week, he appointed an “envoy” to the Federal Reserve to function as a buffer between him and Fed Chair Jerome Powell.

Powell is considered the most likely to be able to stand up to Trump’s overbearing personality since he has been doing a job for eight years that he didn’t want in the first place.

Trump wants inflation to be lower but also wants the Fed to continue to cut rates. This is an unachievable wish list, but he will not accept the blame for having shot himself in the foot over the economy.

While Trump is busy making the world a safer place, for Americans at least, his Department of Government Efficiency, run by the world’s richest man, Elon Musk is taking a sledgehammer to Federal spending.

Thousands of federal employees have received notification that their role no longer exists and are being forced into redundancy as the rush towards deregulation gathers pace.

Chicago Federal Reserve President Austan Goolsbee said last week that he does not expect the inflation reading the U.S. central bank uses to set its inflation target to be as “sobering” as the previously reported Consumer Price Index figures. January’s data for Personal Consumption Expenditures, the Fed’s preferred measure of inflation, is due for publication on Thursday.

Last week, the Labor Department reported a larger-than-expected 0.5% month-on-month increase in CPI for January. The year-on-year figure also climbed back to 3% for the first time since June, having risen each month since September. The comparable Personal Consumption Expenditures Price Index the Fed uses for its 2% inflation target is expected to show a less significant increase.

“The CPI number was not great,” Goolsbee said at a Chamber of Commerce event in Chicago. “The PCE number is probably not going to be great either, but it’s not likely to be as sobering as the CPI number.”

Goolsbee said it’s important to remember that great progress has been made in bringing inflation down from the four-decade highs reached in 2022, but the level of uncertainty around the economy and the evolving policies of the new Trump administration around tariffs may be having an impact.

“My view is, before we got to the uncertainties from policy and geopolitics and from some others, the overall inflation picture looked pretty good to me,” he said.

Several Regional Fed Presidents have made speeches since the FOMC meeting, and they all appear to be singing for the same hymn book. They all believe that the Central Bank is on a sustained path toward looser monetary policy, although the most recent data may slow their efforts down somewhat.

Last week, the dollar index fell to its lowest level since early December. It fell to a low of 106.29 but rallied to close at 106.63.

If it stays above 105.00, its recent fall can still be considered a correction. However, having finished lower every week since late January, it is looking decidedly shaky.

The great debate over the “neutral rate” rages on. In some ways, this conversation typifies a lot of what ails the European Union.

It seems that every member state and its representatives each have an opinion, whether that opinion is relevant or not.

One opinion that certainly is relevant is that of ECB Board Member and Governing Council Member Isabel Schnabel. Along with ECB Chief Economist, Philip Lane, Schnabel is considered by the market to be one of the more reliable voices on the Region’s economy.

Schnabel believes that the neutral rate is an important theoretical concept. But it’s not well-suited to determine the appropriate monetary policy stance. The ECB staff analysis that was published recently had one main message, “we know that we know very little.”

Model and estimation uncertainty results in confidence bands that are so wide that they include any reasonable interest rate that the ECB may set at this point.

Conservative leader Friedrich Merz has triumphed at Germany’s ballot boxes, paving his way to become the next chancellor. His win is of particular significance to Europe — the leader has vowed to strengthen the EU, distance itself from Donald Trump’s America, and extend stronger support to Ukraine.

Germany has spoken. The party once led by Angela Merkel has won the elections, securing 28.5% of the total vote, followed by the far-right AfD at 20%. The country has moved to the right, but not by as much as was feared.

However, if you think Germany will return to the Merkel era, think again.

The leader of the Christian Democratic Union (CDU)/Christian Social Union (CSU) bloc, Friedrich Merz, is set to take the reins of the European Union’s largest economy.

While it is unclear what his government may now look like, one thing is certain, Merz’s idea for Germany is vastly different from his predecessors, Olaf Scholz as well as Angela Merkel.

It falls to Merz to put the final nails in the coffin of Angela Merkel’s legacy.”

German industry is on its knees, and Merz is not considered a “White Knight” who has “miracle powers” to cure Germany’s “sickness.

One of the biggest challenges awaiting Merz is the issue of immigration in Germany. There’s a strong perception in Germany as well as Europe that its borders are not secure, which has driven many voters to extreme parties, although the election of so-called extreme parties in both Italy and the Netherlands and the narrow defeat of the right in France has not seen the sky fall.

Last week’s flash PMI survey data showed the eurozone economy barely expanding midway through the first quarter, putting the region on course for another quarter of sluggish 0.1% GDP growth.

Growth dynamics have changed since late last year, however, with the manufacturing downturn moderating while services growth has trended lower, closer to stagnation.

A changing dynamic is also evident within the region, as France’s downturn intensified in February while Germany and the rest of the region reported stronger expansions.

A near-stalled employment picture likewise masked variations by country and sector, with the latter perhaps most notable in terms of the increasingly severe, and historically steep, job losses being recorded in manufacturing.

The euro lost a little ground last week following its robust performance in the previous week.

It fell to a low of 1.0400 but rallied to close at 1.0460.

Have a great day!