20 January 2025
The recent jump in gilt yields, which was primarily driven by rising bond yields in the US, highlights how events over the pond can cause big ripple effects on Europe, but particularly the UK. With Trump officially taking office today, the economic policies implemented by his administration will potentially have as big an impact on the UK economy as policy changes made by Rachel Reeves over the next four years.
We’ve argued before that while talk of tariffs has captured most of the media attention, direct tariffs on the UK aren’t the biggest risk for two reasons. First, the UK already runs a trade deficit with the US, making it a smaller target for direct action than countries like China which run a large trade surplus with the US. Second, even if tariffs are implemented only about 22% of UK exports go to the US and most of that is services exports, which will probably be exempted from tariffs.
That’s not to say there is no risk. The UK is a medium-sized open economy so if other countries respond to US tariffs by imposing their own, then there is a risk of a more general increase in global inflation and a decrease in trade, which would be ‘stagflationary’ for the UK.
The bigger risk to the UK is a continuation of some of the trends we’ve already seen. 10-year gilt rates have risen by about 50 basis points (bps) since the US election and the pound has dropped from 1.3 to 1.22. That will have the unfortunate consequence of both weighing on economic growth and temporarily boosting inflation. Indeed, Trump’s expansionist economic policies will probably lead to higher inflation and higher interest rates in the US, resulting in a stronger dollar. Assuming the pound fell by 5% against the dollar but was stable against all other currencies (because the dollar is rising against everything), then inflation would probably be about 0.3 percentage points (ppts) higher in 2026. For context, Rachel Reeves Autumn Budget, which was the biggest in a generation, will boost inflation by about 0.5ppts.
Of course, what President Trump says and what he does can be two quite different things. So, there is a chance markets have overreacted and inflationary pressures in the US remain under control, which allows the Fed to continue to cut interest rates. That, in turn, would mean less inflationary pressure and lower interest rates in the UK as well. Indeed, gilt yields have fallen back a bit over the last few days.
At the very least we will all have to start paying a lot more attention to what is going on elsewhere, especially in the US. The RSM Global economic outlook highlights the impact that trade disruptions and a stronger dollar might have on the global economy.
Ultimately, though, along with fiscal pressures, global conflicts and employment trends, Trump will be one of the major macro themes that determines the direction of the UK economy over the next few years. For Rachel Reeves, that makes an already tough challenge that much harder.
- UK wage growth strengthens
- January private sector shrink?
UK wage growth strengthens
We expect wage growth will have accelerated further in the three months to November by 0.1% to 5.5%. But, it won’t worry the Bank of England (BoE) enough to stop them from cutting next month.
The private sector will drive the increase as we expect private sector wage growth to reach 5.8%, up from 5.4%. Base effects will have driven the increase due to a drop in pay from last October not being repeated.
Private sector pay growth will be well above the BoE’s forecast for Q4 of 5.1%, but the central bank has previously dismissed wage data as volatile in the past so won’t put too much weight on it at the Monetary Policy Committee’s February meeting.
Unemployment is likely to have remained at 4.3% in the three months to November, but low responses to the Labour Force Survey continue to distort the figures. Alternative data leaves us fairly confident that labour demand has cooled in recent months, creating slightly more slack in the Labour market.
January private sector shrink?
We expect the flash composite PMI to have nudged down to 49.8 in January from 50.4 in December. A reading above 50 implies growth, below implies the economy is shrinking.
Historically the relationship between PMI and GDP would imply negative growth next quarter if it remains below 50 for the remainder of Q1. However, sentiment influences the surveys quite a lot and we still expect growth to pick up in the coming months.
Crucially, PMI excludes the public sector and with a big spending boost coming from the Autumn Budget we expect the public sector to pay a bigger role in supporting growth throughout 2025.
While the supposed weakness in PMI may be overdone, the risk is that the looming rise in Employers NI will weigh on growth more than expected. Businesses may respond by cutting jobs, reducing hiring and passing costs onto consumers.
The December reading showed that the private sector shed jobs at its fastest pace in nearly four years due to softer demand and growing employment costs. The BoE will be keeping a close eye on the survey.
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