Investor jitters impacting the real economy

Early 2025 has seen much activity on financial markets, with results reflecting strategic concern amongst traders.

This is not just a market issue – consumers and businesses in the “real” economy will be affected.  So, what is causing this unease?

New US President

The unease may be in part down to geo-politics, especially the imminent arrival of a new US President – Mr Trump will be inaugurated on 20 January.

The US economy is currently performing strongly – final figures are not yet in, but growth in 2024 was apparently robust. Labour demand is high, and strong demand is causing inflation to persist.

However, there are concerns regarding US policy under President Trump. He has promised aggressive tax cuts, possibly funded by borrowing.

He has also promised tariffs on goods and a more assertive stance towards other nations, including US allies.

All of this may be inflationary for the US, delaying further reductions in interest rates. This in turn impacts interest rates in other countries – if the US holds its interest rates, others will likely do the same.

Central banks tend to move in unison when setting monetary policy – if the Federal Reserve holds or increases rates, then the Bank of England and European Central Bank will likely do the same.

UK economic performance

Many of these issues in the US will impact UK businesses and the UK economy to some degree. However, other trader concerns are specific to the UK, particularly worries over government finance.

The financial markets have raised concerns about the high levels of government borrowing announced in the Autumn budget.

More recently, yields for both long- and short-term UK gilts have risen, indicating that investors see these assets as increasingly risky and demand higher returns to justify holding them.

The UK government uses debt extensively to fund spending and interest is a major expense. Debt interest is about 8% of government expenditure in the current year.

Higher-than-expected borrowing costs for government can potentially cause financial plans to unravel quickly.

The Chancellor will be keen to reassure markets and may need to take fresh action to manage government spending.

Some cuts may be needed, although it is not easy to see where these might fall. There are no “good” or “easy” choices available.

A few departments account for the bulk of government spending. In the current year, these include:

• Welfare £314bn (24%)

• Health £190bn (15%)

• Education £89bn (7%)

• Defence £38bn (3%)

These are “protected departments” and spending could not be cut significantly without political costs. Any cuts will therefore likely impact smaller departments, hard.

Defra is not a protected department, but its budget is quite small at £2.5bn, not including money for various investment and farm subsidy schemes.  Farm subsidies will add around another £2.5bn, depending on how many farmers applied for payments.

The Chancellor has decided to focus for the moment on government efficiency and cutting waste – as have other Chancellors before her.

Realistically, however, the Chancellor is unlikely to be able to meet her goals via savings alone – however vigorous it is, the process would be slow and difficult.

Unless an economic boom emerges to save the day, further tax increases are likely.  Since taxes on individuals account for most of government income, it is likely that individuals will shoulder the burden, especially as businesses bore the brunt last time.

What it all means

The most immediate real world impact of all this is likely to be seen in interest rates staying higher for longer for individuals and businesses. This would in turn mean lower investment or, at least, make it harder to justify investments.

Further impacts are likely to be seen in currency markets – the Dollar generally does well in uncertain times, due to its status as a “safe” currency.

Finally, we might expect to see fiscal responses – government cuts and / or tax increases. Not great news for consumer facing businesses and likely to push back the horizon of economic recovery.