How Trump’s economic policies could affect UK interest rates
In his recent address to the World Economic Forum in Davos, President Trump was unequivocal. “I'll demand that interest rates drop immediately. And likewise, they should be dropping all over the world”. These two sentences moved bond market interest rates further off their pre-Inauguration highs. The US President’s lack of nuance is perhaps his greatest communication gift. For central bankers skilled in conditional linguistics this is quite the culture clash. Trump parked his hulking snowplough on the manicured piste of the world’s central banks. It looks like this piece of heavy machinery is unlikely to shift for four years. For a man who made his name in highly-leveraged real estate deals, Trump’s preference for cheaper money and lower interest rates appears inevitable.
What does this mean for the UK and its central bank, the Bank of England, as it gears up for its first interest rate decision of the year? At that policy meeting on 6 February, financial markets appear convinced that the third UK interest rate cut of this cycle will be announced. This would take Bank Rate down to 4.5%. It would continue a gradual downward path in rates - consistent with inflation progress, rather than inflation victory. With UK consumer prices ending 2024 2.5% higher than a year earlier – down from a peak of more than 11% in the year to October 2022 - a less restrictive cost of UK money is fully justified.
However the correct level for UK interest rates gets considerably harder to foresee later in the year. Well-documented domestic events – most notably the large increase in employer National Insurance contributions in April – will coalesce with an international backdrop that US-based academics now see as the most uncertain since the onset of the COVID-19 pandemic. Inflationary fears over trade tariffs and UK employers passing on big selling price increases is one scenario. Equally plausible is a China-led disinflation of global goods prices, and lower domestic wage growth. These paths would necessitate a very different policy response from the Bank of England.
The basis of President Trump’s demand are his efforts to flood the global economy with cheap energy, using growth in US energy exports and his relationship with Saudi Arabia to push energy prices lower, and heap financial pressure on Vladamir Putin to end the war in Ukraine. Should Trump be successful in these efforts the Bank of England can reasonably expect downward pressure on UK prices and offset some of the upward pressures from the recent Budget, increases to the National Living Wage, and normalisation of business rates.
Now it may be too much to think the UK may follow suit and revisit its ideological objection to domestic Oil and Gas development, but with a Treasury prepared to put growth above all other objectives this would be the ultimate signal that Securonomics is not just a convenient soundbite. It would certainly suggest Rachel Reeves’ recent call in The Times for some Trumpian positivity is backed by actions. Imitation is the sincerest form of flattery. Increasing domestically-sourced production, rather than shipping it in from thousands of miles away, would have a powerful geopolitical resonance for a US President keen on being flattered.
Whilst the Bank of England can do little more than model the inflation outlook on current energy prices, it can respond to the latest economic data. These signals continue to soften. A technical recession during Q4 2024 and Q1 2025 will be knife edge stuff if the latest indicators are prescient. UK purchasing managers reported very limited growth in January and consumers showed all the hallmarks of a post-Christmas hangover - and a Dry January in more ways than one. Job vacancies continue to trend downwards. This is not a backdrop where businesses will find it easy to pass through price increases, nor feel forced to pay inflation-busting pay settlements.
And it is this recent slowdown in economic growth that could shift the monetary policy spotlight back on Rachel Reeves. Could her current extolling of UK regulators to provide a more favourable ecosystem for growth - a stance that has seen the Chair of the Competition and Markets Authority replaced - extend to how the Treasury mandate the Bank of England to deliver economic policy? It is often overlooked that since 1997 the Bank of England has been given a primary mandate of price stability, in contrast to the US Federal Reserve’s dual mandate that puts employment and price stability on an equal footing. With UK labour market indicators weakening it would be entirely consistent to ask all corners of the UK state to give the support of growth an elevated status. Whilst I doubt it would make a huge difference to the interest rate stance, it would signal intent and be in keeping with the approach of the fastest growing developed economy - the US.
So circling back to the immediate decision on UK interest rates, the newest member of the Monetary Policy Committee, Alan Taylor, gave one of the best inaugural speeches of a UK rate setter that I can recall. As well as outlining the growing downside risks to the UK economy, he was prepared to stick his neck out and suggest the neutral interest rate for the UK economy is 2.75%. Bravo. With events so unpredictable some form of framing expectations is important for businesses looking to invest, and households considering major purchases. More of this from Taylor’s colleagues would, to my mind, have a positive impact on UK decisionmakers who are seeking clarity in an uncertain world.
At present financial markets see between two to three UK rate cuts this year. My expectation is that we will see more as the Bank of England move to shore up confidence. But as we have seen in recent weeks the price that Britons pay for money is as likely to be determined in Washington as it is in London.
