February monthly market update - Reflections on January 2025

Britain’s benchmark share index surged to a record high, marking its strongest monthly performance in more than two years, as lower inflation rate boosted investor confidence.

While pay growth remains strong, signs of a weaker jobs market are emerging. Basic pay, excluding bonuses, increased by 5.6% in the three months to November, up from 5.2% previously, while unemployment rose to 4.4% from 4.3%.

The FTSE 100 index hit a record high after a surprise drop in inflation, raising hopes for interest rate cuts this year. In early January, UK bond yields rose before easing following the release of December’s inflation report. Global bond yields have also risen, fuelled by a broad sell-off that has heightened worries about rising borrowing costs and economic strain.

Concerns over persistent inflation had led to expectations of a slower pace of interest rate cuts, keeping base rates higher for longer. This triggered a sell-off in UK and US government bonds, pushing up yields and increasing borrowing costs, fuelling speculation that Chancellor Rachel Reeves may raise taxes or cut spending to meet fiscal rules.

UK inflation unexpectedly dropped to 2.5% in December, down from 2.6% in November, raising the possibility of an interest rate cut in February. With rates currently at 4.75%, markets anticipate two to three cuts this year.

The UK economy grew by 0.1% in November – less than expected and not enough to offset the previous two months of contraction. British retail sales also unexpectedly declined in December, deepening fears about the economy.

Trump hikes tariffs

There are concerns that Donald Trump’s tariffs on Mexico, China and Canada could derail economic momentum. US stocks edged lower, and bond yields climbed as December's job growth came in far stronger than expected. Employers added 256,000 jobs, well above the forecast of 160,000, while the unemployment rate dipped to 4.1% from 4.2%. Tech stocks were also unsettled by the emergence of a new artificial intelligence app from China called DeepSeek.

Meanwhile, the US Federal Reserve (Fed) left interest rates unchanged in January as inflation remained elevated. US inflation rose to 2.9% in December, up from 2.7% the previous month and in line with expectations. Core inflation eased slightly to 3.2%, down from 3.3% in November.

The Fed began lowering rates from their 23-year high in September 2024, implementing two additional cuts by the end of the year. However, in December, policymakers hinted at a more gradual pace of easing for 2025, highlighting ongoing inflation concerns.

Despite fears of a downturn, the US economy has remained robust in recent years. Worries about the jobs market may have been premature, reducing pressure on the Fed to cut rates.

ECB lowers rates

The European Central Bank (ECB) cut interest rates for the fifth time since June to 2.75% in a bid to boost the region’s flagging economy. Euro area inflation rose for a third consecutive month, climbing to 2.4% in December.

The region's economy contracted slightly at the end of 2024, weighed down by falling new business and employment. December’s decline was mainly due to a sharp drop in manufacturing output, although services activity showed signs of recovery.

Employment also weakened as firms reduced workforce capacity. Among the bloc's largest economies, Germany, France and Italy experienced declines in business activity, while Spain and Ireland enjoyed growth. Spain’s private sector posted its strongest expansion since March 2023.

Europe’s largest economies face weak growth and political challenges. Germany, the EU’s largest economy, has avoided a technical recession, with its economy fluctuating between growth and contraction over the past two years. The government collapsed after disagreements within the three-party coalition over economic policies. France is also experiencing political instability, with centrist Prime Minister François Bayrou heading the country’s fourth government in a year.

China tariff fears

Fears of increased US tariffs and weak domestic demand have weighed on China’s economy. The yuan fell to a 16-month low against the dollar in January, while mainland bond yields and stocks also declined. The prospect of further tariffs has heightened concerns about the Chinese economy, which has struggled despite the unveiling of new stimulus measures last year. According to President Xi Jinping, China’s economy is on course to expand by 5% in 2025.

Consumer price inflation slowed to just 0.1% in December, raising deflation concerns as Beijing’s efforts to revive consumption struggled to gain traction. But exports offered a bright spot, climbing 10.7% year-on-year in December to reach a record high. Imports, which were widely expected to fall, also rose 1%, marking the strongest performance since July 2024.

The world's second-largest economy has struggled in recent years following the pandemic. Beijing has faced challenges in lifting confidence amid a four-year property slump, periods of deflation and high youth unemployment.