Please see this week’s Markets in a Minute update below from Brewin Dolphin, received yesterday afternoon – 25/02/2025.
What’s next for UK interest rates?
We explain how sticky inflation could impact the Bank of England’s interest rate decisions.
The start of 2025 has seen last year’s equity laggards making the early running. Notably, European equities have performed well following a tough 2024. They were perceived as victims of President Trump’s interventionist economic trade policy and as such, they were unloved and under-owned, but have bounced back firmly.
Like all regions, European companies generate a lot of their revenue globally, but unsurprisingly, they’re the most exposed to European economies. Around 30% of the revenue generated by European companies comes from the region, so when a domestic economy struggles, it has a market impact.
Has the outperformance of European equities reflected a less antagonistic stance from the Trump administration? Far from it. If anything, investors might be more concerned about the challenges posed by President Trump’s actions now than they were before the U.S. election. His tone has been strangely antagonistic towards Europe.
U.S. geopolitical focus adds pressure on Europe
A couple of weeks ago, we discussed the suggestion that the U.S. administration might consider value added tax (VAT) as a barrier to trade – despite logic and research arguing otherwise. Last week, the pressure on Europe shifted to geopolitics, with Secretary of Defence Pete Hegseth telling the Munich Security Conference that Europe should foot most of the bill for Ukraine’s defence against Russia.
Hegseth said returning to pre-2014 Ukrainian borders (when Russia annexed Crimea) was unrealistic, and that NATO membership for Ukraine was also an unrealistic prospect. To underpin the weakness of Ukraine’s negotiating position, President Trump seemed to parrot Russian propaganda by referring to Ukrainian President Volodymyr Zelenskyy as a “dictator” (Ukraine has not held wartime elections).
The Trump administration continues to emphasise that European defence spending should reach 5% of gross domestic product (GDP), a level above the current NATO pledge of 2%. That may be bluster, but the pressure on European countries to meaningfully increase defence spending is real. The difficulty is that most have very limited fiscal scope to do so.
The economic situation in Europe
Some countries, such as France, were already struggling to rein in their borrowing, after having toppled Michel Barnier’s government due to its attempts to take tough choices and reduce borrowing.
The twin needs of higher defence spending and restored public sector balances imply the need for some very difficult political choices, and a net contractionary fiscal policy.
It’s an unwelcome situation for France, which has been struggling economically. France and Germany have substantial manufacturing sectors, which have been experiencing difficulties through a global downturn. Recently, the services sector has also been looking fragile. Friday’s flash estimate of French economic activity from the purchasing managers indices (PMIs) was strikingly weak, driven by a marked deterioration in the services sector. The data may be anomalous.
Neighbouring Germany’s equivalent results were much less stark, as was the broader Eurozone PMI. France’s political and debt situation is distinctly worse than that of many of its European peers. This might be unsettling to its shoppers, but consumers are generally insensitive to these things – until they feel the cost of them in terms of wages, job losses, or inflation. Economic pressure therefore remains for Europe.
However, the prospect of an end to hostilities in Ukraine does bring potential economic benefits. Moscow could increase the gas flow to Europe if peace talks are successful. That would be welcome because replenishing gas storage for next winter is another worry for European leaders. There should also be huge opportunities for construction and redevelopment activity in Ukraine once the conflict has ended.
Like France, the UK saw an implied contraction in its manufacturing and services sectors but that contrasted with a lot of other data out last week. Employment data, whilst notoriously unreliable, suggested that employment numbers weren’t dropping. Wage growth was fast and, even though inflation data was strong, the implication was that UK wages are rising faster than inflation, contributing to stronger-than-feared retail sales growth.
Interest rates have been coming down recently, which provides further support, and the shock of high mortgage rates is beginning to ebb. Consumer sentiment edged higher, begging the question: why are the business surveys so weak?
Some of this could simply be temporal. Consumers are enjoying the decline in inflation over the last two years, cuts to National Insurance contribution rates, and rising house prices. Businesses, however, are planning on how to address the steep increases in employers’ National Insurance contribution rates.
Europe’s next move
The results of this weekend’s German elections have landed, showing centre-right Christlich Demokratische Union (CDU) and centre-left Sozialdemokratische Partei (SDP) winning a majority of the seats in the Bundestag. The new coalition will have big implications for the German economy and beyond. It’s likely it will want to reform the strict national debt brake enshrined within the German constitution – however, this requires a two thirds majority, which it didn’t receive.
The results were in line with pre-election polling and suggest that a two-party coalition can be formed. Whilst that will require cooperation from the centre-left and centre-right parties, it’s considerably more manageable than a three-party government including the Greens.
Tariffs a source of uncertainty for U.S. businesses and citizens
The stream of announcements on U.S. trade tariffs, and subsequent delays or amendments, makes for an unusually opaque economic policy environment, which must be weighing on companies to some extent. There’s some limited evidence that it’s also affecting the U.S. public.
President Trump’s approval rating has been dropping since he took office, which isn’t unusual. Although the economy has remained strong, and the President has been proactive, this suggests that some of his actions are jarring with segments of the public. A majority believe he should have done more to bring down prices. Whilst that’s an unrealistic expectation, it’s one he did little to dispel on the campaign trail and the landmark policies of imposing tariffs and limiting inward migration are inflationary in nature.
Federal employees in particular will be concerned about their futures given the actions of Elon Musk and the Department of Government Efficiency. A recent poll found that just 39% of the public approved of the President’s handling of the economy. This is a decline of 4% from the end of January, after which we’ve had a flurry of confusing announcements on tariffs.
As a reminder, trade tariffs affect many U.S. businesses because they import components, and they affect consumers because ultimately, the cost of import tariffs will typically be paid by U.S. consumers.
At the end of last week, the University of Michigan Consumer Sentiment Survey seemed to underpin this. It showed consumer expectations for inflation in the coming five to 10 years increased to the highest level in nearly 30 years. Meanwhile, the S&P Global Purchasing Managers Index noted a significant shift in business activity in February from just a couple of months previously, which it attributed to “widespread concerns about the impact of federal government policies, ranging from spending cuts to tariffs and geopolitical developments.”
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Charlotte Clarke
26/02/2025
