April 2025

Developments in global tariff policy present a major downside risk to the UK economy, but the impact on UK inflation is less clear. Rates are set to be cut in May, yet despite the global growth picture now looking very uncertain, caution about continuing the rate-cutting cycle over the summer will be required as MPC members contend with projections for elevated CPI through 2025 and worries around consumer inflation expectations becoming unanchored from the 2% target.

Earlier this year, the signs were mixed about near-term prospects for the UK economy. Confidence certainly remained subdued as concerns around some measures in last year’s October’s Budget persisted and consumers expressed worries about future price rises. However, certain indicators suggested signs of some cautious optimism: for example, February’s m-o-m GDP print was strong while March’s retail sales were relatively bullish.

That is now all, of course, a distant memory with the economic outlook being completely upended by President Trump’s tariff announcements on so-called “Liberation Day”. The tariffs were considerably more punitive than we and most other forecasters expected, prompting financial markets to be incredibly turbulent over the course of April (which Jasmine covers in detail in her section below).

As April has progressed, there has been some “de-escalation”; in particular, the “90-day pause” cooled the temperature between the US and the majority of other countries, and the US Treasury Secretary’s recent comments suggesting future de-escalation between the US and China has served to somewhat calm markets. Nonetheless, global developments in tariff policy over April will have a significant negative impact on UK growth prospects. There will, of course, be a direct impact on the UK from the 10% across-the-board tariffs along with higher sectoral tariffs on cars and potentially pharmaceuticals as well. Moreover, there will likely be an even more material macroeconomic impact arising from broader global trade dislocation. The UK is, after all, an open economy with its collective imports and exports being equivalent to 64% of GDP. For comparative purposes, the equivalent figure for the relatively-closed US economy is just 25% of GDP (see Figure 1).

It is notable that the impact on business confidence is already showing up in survey data, with the UK PMI plunging into contraction territory (51.5 in March to 48.2 in April), although this may be overestimating the drop in sentiment given it is not completely clear how much of the “de-escalation” is captured within the survey results. However, while there will clearly be a negative impact on UK growth from global tariffs, the impact on inflation is less clear. It is plausible that there could even be some deflationary impact given the growth-suppressing nature of tariffs. MPC member Meghan Greene, has also highlighted the prospect of Chinese exports previously destined for the US being re-routed to the UK and other markets at lower prices.

Even so, inflation remains a serious concern for rate-setters. We are still expecting an inflation spike this year, something I set out in last month’s Rate Wrap, and all signs continue to suggest that the domestically-generated component has risen relative to non-core elements such as energy prices. And while March’s CPI print registered at 2.6%, a welcome undershoot compared to market expectations, April’s CPI print is expected to jump to around 3.5% and then forecasts point to inflation being north of 3% for the remainder of 2025.

Markets have made a dovish pivot with respect to the base rate pathway in 2025, now predicting three to four further rate cuts by year end (as of 25.04). We agree with financial market pricing that a May rate cut is now effectively a certainty, but the BoE will need to be cautious about continuing with rate cuts during the summer. The weakening global growth outlook would certainly point in a dovish direction, but MPC members will need to contend with April’s elevated inflation print along with projected inflation persistence across 2025 at a time when consumer expectations may be “unanchored” from the 2% inflation target.

That said, our base case view remains that the rate-cutting cycle will eventually continue down to 3.5% by 2026, but the last few weeks highlight just how uncertain all macroeconomic projections are at the moment.

Daniel Mahoney, UK Economist

• The Rose Garden tariffs announcement had pretty drastic immediate shockwaves throughout financial markets, and the long-lasting effects are yet to be seen. 
• Concerns remain as to whether global economies will see a direct inflationary impact of higher imports or whether this is offset by weaker growth
• Weaker inflation has shifted expectations for three rate cuts this year, but the threat of upside risk to inflation may put a question mark over this. 

All eyes were on Trump’s “Liberation Day”, and as expected it did not fail to send markets into a frenzy. The risk of weaker economic growth prospects for the US rippled through the market pricing, and the shift in interest rate expectations was reflective of perhaps an overreaction from markets. I’ve talked in previous editions of the Rate Wrap around the emotional side to markets, and how some moves can be driven from a place of fear. 

The bond markets were taken on a rollercoaster ride this month, and volatility was the buzzword of the month (yet again). The fall in US Treasury yields in the immediate aftermath of the tariff announcement suggested that markets expressed more concern about the health of the US economy than was already evident in the data before the tariff announcement. Market pricing shifted to price in five more cuts in 2025 to be delivered by the Federal Reserve. However, this reaction whipsawed on speculation of foreign selling of US debt and the unwinding of a popular hedge fund trade, alongside some speculation that countries such as China could re-evaluate their positions in US government debt. 30-year Treasury yields were hit by the US asset sell-off, reaching 4.94% before retreating – close to that all-important 5% psychological barrier.

US government bonds are traditionally seen as a safe-haven asset, but US assets took a hit as a whole amid fears that a global trade war would trigger stagflation and therefore hamper the ability of the Federal Reserve to cut rates. The dollar also has taken a hit, which is an unusual move given that there is a relationship that as yields rise this typically strengthens the local currency. Equities fell, and the VIX index (nicknamed Wall Street’s “fear index”) traded at levels last seen in 2020 around the onset of the pandemic.

The impact on bond markets wasn’t isolated to the US either – markets grappled with the fear of a worst-case scenario global trade war. Benchmark yields in Australia, New Zealand and Europe spiked, with JGB Japanese 40-year bond yields hitting a record high. UK borrowing costs surged to the highest levels since 1998, with 30-year Gilt yields climbing to 5.50%, in a painful move for Chancellor Rachel Reeves and the lack of fiscal headroom. 

It's not all doom and gloom though – we have since seen a reversal to this move, and UK 5-year Gilt yields are now back below 4%, a level last seen in mid-October, pre-Budget. The 5-year swap rate is back below 3.70%, with the 10-year swap rate dipping below 4% (as at 28/04). Market expectations for base rate have shifted markedly too. If we look back to Tom’s Rate Wrap last month, we were eyeing up the potential for two more cuts before year end, which would take us to 4% base rate at the end of 2025. However, fast-forward to now (as at 28/04), we have seen a shift to three cuts fully priced in by November, and the chance of another seen by some. This is a far cry from the less than 1% chance priced in for base rate to fall to 3.75% at the start of 2026 as at the back-end of March.

Part of this shift can be attributed to the slowdown in activity data, and the softer-than-expected inflation reading has been a welcomed result. As Daniel discusses above, there is the chance that we see inflation spike back up to 3.5% for this month’s reading. This begs the question of whether market pricing is based on overly optimistic expectations that inflation continues to surprise on the downside. On the other hand, the stir that US tariffs and global trade policy “end-state” has potential to create a drag on export growth for the UK, which has also weighed on consumer sentiment, contributing to a fall in swap rates.

Overall, softer UK labour figures coupled with a weaker-than-expected March inflation print have tipped the scales for markets to fully price in a cut by the Monetary Policy Committee at May’s meeting, but the future is more murky (as Daniel concludes above). The MPC is likely to remain cautious as strong wage growth continues, and will be eyeing any upticks to inflation. The political developments around global tariff policy continue to raise questions, and will be closely monitored to see whether the fall in cargo shipments from China to the US this month will lead to disruption, increased prices and uncertainty. The only thing that is certain is uncertainty!

Jasmine Crabb, Capital Markets