January market update - Reflections on December 2024

UK share prices made strong gains in 2024 even though inflationary pressures persist and economic growth has been slower than expected.

It was a mixed month for UK shares after hopes faded of rapid interest rate cuts in the UK and US following strong pay data and an increase in inflation. After a relatively quiet month, prices rallied on the final trading day of the year to help the FTSE 100 gain 5.7% over the course of 2024.

The Bank of England held interest rates steady at 4.75% despite a struggling economy, prolonging the pressure on businesses and households from high borrowing costs. Inflation increased for the second month in a row, reaching 2.6% in November, while wages grew by 5.2% in October, up from 4.4% in September. Unemployment remained unchanged at 4.3%.

The pound reached its highest level against the euro since the Brexit vote as the European Central Bank (ECB) prepared to cut rates. UK government bond yields also rose, reflecting expectations that the Bank of England will cut rates more cautiously than the ECB. There are concerns that UK inflation and rates will fall by less than expected after the Autumn Budget delivered an increase in spending and borrowing.

The UK economy contracted by 0.1% in October, following a similar decline in September, posing a challenge to the Labour government’s economic plans. The unexpected fall in GDP was driven by declines in construction and manufacturing, while the dominant services sector stagnated. Business groups have complained that measures announced in the Budget have added to their costs and deter investment.

UK companies are cutting jobs at the fastest rate since early in the Covid-19 pandemic in response to increases in employers’ National Insurance Contributions in October’s tax-raising Budget. Business optimism fell to the lowest level since December 2022, largely due to an ongoing slide in service sector confidence. Output among UK manufacturers contracted at the fastest pace for almost a year in November.

Fed cuts rates

The US Federal Reserve (Fed) reduced interest rates by 0.25%, but signalled it may slow the pace of cuts in 2025, sending the dollar higher and US stocks lower. While inflation has eased since its 2022 peak, it remains above the Fed's target. US inflation rose to 2.7% in November, up from 2.6% the previous month. Core inflation – which removes more volatile food and energy prices – held steady at 3.3%.

Economists believe the Fed will also have to take a more cautious approach to interest rate cuts on fears that Trump’s policies will stoke higher inflation. If Trump imposes import tariffs on some of America’s largest trading partners, the central bank may have to reduce borrowing costs more gradually, leaving interest rates higher for longer. Trump has said he may impose a levy of up to 10% on Chinese imports and increase taxes on goods from Canada and Mexico.

The US labour market remains robust, with 227,000 jobs added in November. However, unemployment inched up to 4.2% from 4.1%. This follows a slow October, with just 12,000 jobs added, partly due to hurricanes and a strike at aircraft manufacturer Boeing. The economy continues to expand, with GDP rising 2.8% in the third quarter. Consumer spending, which drives most economic activity, is growing at a solid 3.7% pace.

Euro area faces further setbacks

European share price fell amid political turmoil in France and Germany, while the euro weakened against major currencies. The ECB cut interest rates for the fourth time this year, lowering them by 0.25 percentage points to 3%. The central bank said its efforts to bring inflation back to 2% are on track, but economic growth is likely to fall short of earlier forecasts.

Inflation across the region rose to 2.2% in November, up from 2% in October. The euro also faced pressure from concerns over potential US trade tariffs affecting exports. Political instability in France and Germany, the bloc's largest economies, has further clouded growth prospects.

French Prime Minister Michel Barnier resigned after losing a no-confidence vote, becoming the country’s shortest-serving leader in modern history. This followed the collapse of Germany's government in November.

France and Germany make up almost half of the region's economy. With European activity already lagging behind the US and China, political paralysis in France and Germany could derail its competitiveness even further.

China's economic problems deepen

China's economy is slowing, with signs that government efforts to revive growth are struggling. Retail sales growth fell sharply in November, rising just 3% compared with 4.8% in October. Spending on fixed assets like buildings and equipment also slowed, though industrial production grew by 5.4%.

To offset a prolonged property slump, which saw investment drop 10.4% from January to November year-on-year, Beijing has increased spending on high-tech industries. However, exports grew more slowly than in the previous month.

It has been a lacklustre year for the Chinese economy, which has struggled to rebound from the pandemic. Beijing has faced challenges in lifting confidence amid a four-year property slump, periods of deflation and high youth unemployment. In recent months, the government introduced measures to support the stock market and refinance local government debt.

China is now on track to achieve its annual 5% growth target, but many economists expect activity to slow this year. Tensions with the US could escalate following Trump’s election victory, raising the risk of new tariffs on Chinese goods.