No return to cheap money

No return to cheap money

Interest rates reached the highest levels in over 15 years in the US and Europe in 2023 as central banks sought to squeeze inflation out of the system. The peak in rates was short-lived. The European Central Bank made its first rate cut in May of last year, followed by the Bank of England in July and the US Federal Reserve in August. US rates now stand 100bp below their peak; euro area and UK rates have dropped by 75bp.

• Financial markets think rates are unlikely to fall dramatically from here. The scope for rate cuts seems most limited in the US where the economy is running hot and expectations for growth and inflation are climbing. The Fed has made clear that it is in no hurry to reduce rates and financial markets are pricing in only one full 25bp rate cut this year, taking US rates to the 4.0% mark by December. 

• The outlook for UK activity has deteriorated since the summer and earlier this month the Bank of England halved its forecast for GDP growth in 2025 to 0.75%. Activity in the second half of last year was almost flat, yet inflation rose from a low of 1.7% in September to 3.0% in January, partly on higher energy and food costs. Inflation is likely to edge higher still over the summer to around 3.5% before falling back. Markets think that the Bank of England will be prepared to ‘look beyond’ the current uptick in inflation and expect rates to be cut by 25bp in May and again in autumn, taking the base rate to 4.0% by the end of this year.

• The outlook for growth in the euro area has also deteriorated and at a faster rate than in the UK. With inflation looking more constrained than in the US or the UK, markets are pricing in three 25bp rate cuts by the European Central Bank this year, taking rates to around the 2.0% mark, half the expected rate in the US or the UK.

• Whatever the precise timing of changes in rates, what I find most striking is the markets’ assumption that the days of sub-1.0% interest rates, which became the norm between 2009 and 2021, are over. Markets believe that in the long term, rates will run at around the 4.0% mark in the US and the UK and at about 2.3% in the euro area – rates that are close to those priced in for the end of this year. On this view governments, consumers and corporates are going to have to get used to far higher funding costs than in the 2010s.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 0.8% at 8,659.

Economics

• US president Donald Trump said he may impose a tariff of 25% or “substantially higher” on imports of cars, pharmaceuticals and semiconductors 
• US stock market indices, S&P 500 and Nasdaq 100, both hit record highs last week despite concerns over new tariffs and a cautious Fed
• UK earnings growth accelerated – average regular weekly earnings in the final quarter of last year were 5.9% higher than the same period in 2023, driven by strong growth in the private sector
• UK inflation rose to 3% in the 12 months to January, its highest level in 10 months as services and core inflation both rose
• The UK public finances hit a record surplus of £15.4bn in January – well below the £20.5bn forecast by the Office for Budget Responsibility, highlighting the parlous state of the UK public finances
• UK consumer confidence saw a modest rise in February following the Bank’s quarter-point rate cut but savings intentions remained unusually high
• UK retail sales volumes rose by 1.7% between December and January, ahead of expectations
• Tomorrow, the UK energy regulator is expected to announce a 5% rise in the price cap for domestic energy bills from April, according to estimates from Cornwall Insights. The development will place upward pressure on headline inflation
• Japanese inflation rose to 4% in the 12 months to January, strengthening the case for rate hikes by the Bank of Japan

Business

• The FT reports that carmakers have stepped up investment in petrol and hybrid vehicles and slowing the changeover to EVs
• BMW has put a £600m investment in producing electric Mini in Oxford on hold
• Microsoft claimed a major breakthrough in computing that it claimed would allow it to develop a useful quantum computer in “years, not decades”
• UK-based Lloyds Banking Group raised its provision for car finance mis-selling from £450m to £1.2bn ahead of a Supreme Court appeal expected in April. Some estimates suggest that the industry may have to pay out tens of billions in compensation
• Four banks settled cases with the UK competition watchdog over the sharing of sensitive information on gilt-trading between 2009 and 2013
• UK chancellor Rachel Reeves said she wanted to “create more of a culture in the UK of retail investing” following reports that she was considering lowering the limit on tax-free cash savings under the ISA scheme to encourage greater investment in stocks and shares
• Shares of European defence firms rose last week ahead of an expected increase in European defence spending
• Mining giant Glencore said it was considering moving its share listing from London, in a potential blow to the market that has seen a number of companies delisting in recent years
• Private equity activity in the UK rose to £63bn last year, close to the record high of £68bn in 2021, according to figures from Dealogic
• The UK High Court approved a £3bn interim refinancing package for troubled utility Thames Water, avoiding a collapse into administration. Thames Water and five other water companies are challenging their funding settlements from the regulator

Global and political developments

• Exit polls on Sunday in Germany put the centre-right CDU in top place with 29% of the vote with the far-right AfD coming second with its best-ever showing of 20%. The leader of the CDU, Friedrich Merz, is now expected to try to form a coalition but has ruled out governing with the AfD
• US and Russian officials convened for high-level talks in Saudi Arabia and agreed to form negotiating teams to seek to end the war in Ukraine
• The talks, which came as a “surprise” to Ukraine, and other comments by US president Donald Trump have led some to claim that we are witnessing the breakdown of the transatlantic alliance
• The EU announced its 16th package of sanctions on Russia, targeting the oil and aluminium exports
• UK prime minister Keir Starmer said that he would be willing to deploy British troops to Ukraine in the event of a peace deal but that a “US backstop” would be needed
• Keir Starmer is due to travel to Washington this week to meet with Donald Trump
• Swedish police announced that they are investigating suspected sabotage of an undersea telecommunications cable in the Baltic Sea
• Poland’s government and opposition both accused each other of attempting to interfere with upcoming presidential elections in May. Judges appointed by the nationalist Law and Justice Party announced a probe into the pro-EU government for allegedly planning a coup while the government warned that the same judges may annul the result if their preferred candidate does not win

And finally… Venezuelan kayaker Adrián Simancas had a narrow escape after he was briefly swallowed by a humpback whale off the coast of Chile. Mr Simancas said, “I felt a slimy texture brush my face” and reported that all he could see was dark blue and white – inside information