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27 May 2025 | 3 minutes to read
Headline UK Consumer Prices Index (CPI) inflation jumped to 3.5% over the 12 months to April, up from 2.6% to March, according to figures from the Office for National Statistics (ONS). The jump in the print was not unexpected given that various household bill increases kicked in from April, but the scale of the increase did surprise forecasters and may serve as a shot across the bows for the Bank of England (BoE). Indeed, BoE Chief Economist, Huw Pill, commenting ahead of the CPI release last week, suggested that the pace of interest rate cuts had been “too rapid”, and urged greater caution on the part of Monetary Policy Committee (MPC) colleagues before voting in favour of additional rate cuts. While there may be more positive news on the horizon, with it also being reported that UK energy bills are to fall 7% from July, signals remain mixed. Falling wholesale energy and commodity prices should belatedly filter through to customers, and inflation in the services sector has also faded over the past year. Nevertheless, services sector price pressures remain higher than policy makers would like, and it is possible that employers are passing on wage cost increases following last year’s Budget. Elsewhere, manufacturing activity continues to shrink, and employers here are shedding jobs at an increasing rate. Some economists now do not expect the BoE to cut rates more than one further time in 2025. Financial markets are still anticipating two more rate cuts, to 3.75%, by year-end.
Alongside the uncomfortable inflation data, higher-than-expected government borrowing figures piled further pressure on Chancellor Rachel Reeves, raising the prospect of additional tax hikes. The budget deficit rose to GBP 20.2bn in April, when GBP 17.9bn had been anticipated. The figures will inevitably make it even harder for Reeves to meet her self-imposed fiscal rules amidst increasing spending pressures, sluggish growth and high interest rates. While tax receipts were notably higher in April due to increases in employers’ National Insurance contributions, government expenditure rose more significantly following public sector pay hikes and other cost increases linked to inflation.
In a deal struck by the UK government with the EU last week, it might appear that the UK can have its cake and eat it. Recently the government agreed unilateral trade deals with the US and India. Now a reset with the EU is under way. Pacts on security and defence and diluted rules on food imports may aid economic growth – with estimates of the benefit ranging from 0.3% to 0.7% of GDP. In return, the UK is extending fishing rights in territorial waters by 12 years and agreeing to the European Court of Justice’s oversight. The overall outcome still constitutes a relatively ‘hard’ Brexit, with no major “red lines” - such as a customs union - crossed. But there is perhaps now a slightly softened stance and a pathway to increased cooperation with the EU. Net UK migration will impact future growth and productivity. And the very elevated levels of recent years were last week reported to have dropped notably. Net positive migration almost halved in 2024 according to the ONS, dropping to a still historically high 431,000.
Credit rating agency, Moody’s, downgraded the US Sovereign rating from the top-notch Aaa to Aa1, its first downgrade of US sovereign debt since 1917. Additionally, Moody’s changed its outlook for the US from stable to negative, warning of an increasing budget deficit and ever rising levels of government debt. Moody’s now anticipate the federal deficit widening to almost 9% of GDP by 2035, up from 6.4% in 2024.
The 10-year US Treasury yield rose to c.4.5% on the back of the announcement, the highest level since February, while 30-year Treasury yields rose above 5%, reaching levels not seen since November 2023. Equities were less impacted as US stocks ended flat on the day.
The decision by Moody’s comes amid growing investor concern and uncertainty regarding policy direction under President Trump. Many market participants feel the downgrade has been a long time coming, with public finances continuing to decline. Moody’s is th elast of the major credit rating agencies to strip the US of its top rating. S&P was the first to downgrade the coveted triple AAA rating in 2011, while Fitch took the decision to move in 2023.
Despite Moody’s latest assessment, US President Donald Trump unveiled his latest spending spree last week, which he dubbed the “Big, Beautiful Bill”. And there was no doubting the size. Estimates show the bill will add a further USD 3.8trillion to the budget deficit, as the House of Representatives voted in favour of increasing the debt ceiling. The bill extends many of the expiring tax cuts that were implemented during Trump’s first presidency in addition to further spending to make good on promises made during last year’s election campaign. The act saw a USD 150bn boost to defence spending, and a further USD 50bn provided for border security. The bill also abolishes taxes on tips and overtime work. On the flip side, the bill did contain some notable spending cuts, with the Medicaid healthcare programme and support for lower income families both impacted. The bill only passed through the House of Representatives by the narrowest of margins, with a vote of 215 to 214. It will now be scrutinised by the Senate, where alterations to some provisions in the bill are likely.
The Japanese government bond market saw sharp volatility last week, with a 20-year bond auction recording the weakest demand since 1987 – underscoring growing investor caution. Yields surged (as bond prices fell) - driven by concerns over elevated inflation at 3.6% and public debt approaching 240% of GDP. Despite higher bond yields, real returns remain negative after adjusting for inflation. These shifts may signal the end of Japan’s era of ultra-cheap borrowing, as debt costs begin to normalise in line with other major economies.
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