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27 Jan 2026 | 3 minutes to read
Financial markets whipsawed last week as US President Donald Trump dominated the agenda at the 2026 World Economic Forum in Davos. Tensions over the future status of Greenland were front and centre – with Trump apparently insisting that the US required ownership of the autonomous Danish territory for national security reasons. The US President leveraged the threat of additional trade tariffs on eight European nations resisting his push to acquire the land. However, markets were ultimately calmed after Trump publicly ruled out any use of force during his Davos speech, before also walking back his tariff threat. Trump confirmed that he would not impose further tariffs on the group of European countries, which included the UK, from 1 February after a “very productive” meeting with NATO Secretary General, Mark Rutte. This meeting apparently led to an agreement on “the framework of a future deal” over Greenland. However, little additional detail on this was forthcoming, and the de-escalation was insufficient to avoid an indefinite suspension of the EU’s pending trade deal with the US. While a retaliatory package of trade measures against the US – prepared ahead of the agreement signed by Trump and European Commission President Ursula von der Leyen last summer – is itself to be suspended for a further six months, the European Parliament will now not move forward with the ratification of last year’s agreement. The landmark transatlantic trade deal set US tariffs on EU imports at 15% in exchange for the bloc not levying tariffs on US imports.
The Consumer Prices Index (CPI) measure of inflation in the UK rose by 3.4% in the 12 months to December 2025, up from 3.2% in the 12 months to November, according to the Office for National statistics (ONS). It was the first time the UK rate of inflation had been pushed higher in five months, with the greater than expected increase driven by higher airfares, as well as rising food, alcohol and tobacco prices. Nevertheless, the presence of one-off factors in the December data, such as flight costs over Christmas and a hike in tobacco tax, means that the print is unlikely to presage a longer upward trend in prices. Inflation is still forecast to decline throughout 2026, with the Bank of England’s (BoE) 2% target expected to be within reach well before year end. The latest data comes ahead of the first meeting of the year for the BoE’s interest rate setting Monetary Policy Committee (MPC) on 5 February. A reduction in borrowing costs at this meeting is unlikely, with inflation and wage growth still too elevated for policy makers’ liking. But rates are expected to continue dropping gradually this year. On the subject of wage growth, the ONS also released new UK labour market data last week. This showed payrolls falling more than expected and wage growth slowing, whilst overall unemployment held steady at 5.1%. Some observers felt that the slightly dovish headlines could be enough to see the MPC cut rates come the third meeting of the year in April, although futures markets don’t price another cut until June.
Japanese Prime Minister Sanae Takaichi’s announcement of an early Parliamentary election on 8 February led to sharp market moves last week. Seeking a mandate to press ahead with expansionary fiscal policies, the move revived what investors have dubbed the ‘Takaichi trade’ – favouring sectors aligned with national priorities such as nuclear energy, artificial intelligence and defence. However, the policy pledges have also unsettled bond markets. Takaichi’s key proposals include a two-year suspension of an 8% food and beverage consumption tax. While potentially supportive for growth, such measures raise concerns about Japan’s already stretched public finances. Japan’s debt-to-GDP ratio is amongst the highest in the world, standing at c.216%. And investors fear that tax cuts would further widen the budget deficit, requiring the issuance of even more Japanese Government Bonds (JGBs) to fund it.
Such concerns triggered a sharp sell-off in JGB’s, with yields spiking higher as investors demanded greater compensation for rising fiscal risk. The 10-year JGB yield climbed towards multi-decade highs around 2.26%, while longer-dated 40-year yields spiked above 4% for the first time. Volatility eased after the Japanese government stressed the tax suspension could be funded without issuing more debt, although no alternative plan was forthcoming. The move in JGB yields seemed to drag developed market government bond yields up elsewhere too, while higher JGB yields also revive ongoing concerns around the reversal of the yen carry trade, whereby capital which has moved out of Japan in search of higher yields elsewhere is repatriated. Japanese investors are the largest foreign holders of US Treasury securities, with c.$1.2trn. The yen also weakened further on the news. A weak currency has become problematic for Japanese policymakers, pushing up import costs and inflation, and denting households' purchasing power. The Bank of Japan (BoJ) left its key policy rate unchanged at 0.75% at its January meeting. After raising rates very gradually since early 2024, the central bank signalled further rate hikes would follow if the economy and price conditions align with its forecasts. Nevertheless, the BoJ’s path to policy normalisation is further complicated by the volatility caused by last week’s political upheaval.
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