Trump’s Inflationary Triple Threat

Economic

Summary:

With unified Republican control of the White House and Congress, US President-elect Donald Trump is poised to pursue radical economic policies. By undermining the independence of the Federal Reserve, enacting massive tax cuts, and loosening cryptocurrency regulations, he risks triggering an inflationary surge.

BERKELEY – In 1919, John Maynard Keynes famously declared, “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.” Keynes attributed this insight to Bolshevik leader Vladimir Lenin, who argued that currency debasement was the “best way to destroy the capitalist system.”

Recent events offer a painful reminder of Keynes’s prescience. The 2021-23 inflation surge in the United States, though mild compared to the aftermath of World War I, was enough to spark widespread voter frustration and anger. The outcome is unified Republican control of the White House and Congress under a president-elect who, just four years ago, tried to overturn his own electoral defeat.

Now, Donald Trump’s second administration is poised to introduce radical economic-policy changes. While these measures could have far-reaching consequences, many voters may not realize what they are in for.

PLAYING WITH FIRE

With the election having given the Republicans a political trifecta, some soon-to-be-empowered Trump supporters appear eager to risk higher inflation. Three components of Trump’s economic agenda, in particular, pose a threat to US price stability: limits on the independence and authority of the Federal Reserve; extensive tax cuts despite massive federal budget deficits and debt (and reliance on magical thinking to maintain fiscal sustainability); and the integration of lightly regulated cryptocurrencies into America’s financial and fiscal systems.

These policies complement each other. Trump’s bid to gain greater influence over Fed decisions, for example, is tied to his plan to ease cryptocurrency regulations and explore ways to pay off the national debt with digital coins.

Techno-libertarians like Elon Musk often view the Fed’s ability to print money as a dangerous concentration of government power that enables massive federal budget deficits. Instead, they advocate a system of “sound money” based on potentially competing decentralized cryptocurrencies. This approach, combined with deregulation-fueled economic growth and impractically large cuts to government spending (Musk claims that $2 trillion can be cut), would ostensibly eliminate fiscal profligacy.

Let’s start with the Fed. Some critics blame the surge in US inflation on monetary policy, accusing the Fed of destabilizing prices through unchecked money printing to finance federal budget deficits. But this narrative is at odds with reality. The Fed exemplifies modern best practices in monetary policy, targeting low inflation while maintaining independence from political pressures, including those related to public deficits. Although this model has been immensely successful and adopted worldwide, Trump and his allies are seeking to undermine it by curtailing the Fed’s independence and authority.

The chart shows global and US consumer-price inflation rates since 1980, revealing several key trends. A significant reduction in worldwide inflation followed the introduction and widespread adoption of central-bank independence beginning in the late 1980s. Advanced-economy central banks, adhering to similar best practices in monetary policy, have generally maintained inflation rates close to their target of around 2%. In other words, contrary to detractors’ claims about the Fed’s excessive monetary largesse, the US is not an outlier.

In fact, four decades of data show that the 2021-23 inflation spike was the outlier. It affected all countries exposed to the extraordinary shocks of the post-pandemic economic reopening, unleashed pent-up demand, and Russia’s invasion of Ukraine. By 2024, however, inflation had nearly returned to target levels without triggering significant increases in unemployment.

Moreover, the notion that the Fed bankrolls US budget deficits by printing money for the Treasury to spend is pure fiction. In normal times, the Fed controls inflation through its policy interest rate, raising it to push inflation down when necessary and lowering it when the economy is weak and inflation is subdued. By closely following this approach – independent of political considerations – the Fed fosters an environment that encourages market actors to expect moderate long-term inflation and adjust prices accordingly. The result is a virtuous cycle of price stability.

What role, then, does money creation play in this system? Based on the interest rate it sets, the Fed simply adjusts the money supply to align with market demand, creating or withdrawing cash as needed.

The success of central banks over the past four decades stems directly from the independence that domestic critics of US monetary policy seek to strip from the Fed. Market confidence, built over decades of strong performance by professional and independent central banks, stabilized inflation expectations during the recent price surge, allowing inflation to fall rapidly toward target levels without causing a global recession.

Far from enabling fiscal deficits by keeping borrowing costs low, many central-bank leaders have consistently emphasized the importance of fiscal consolidation and maintained appropriately restrictive interest rates, even in the face of high public deficits. In this era of economic turmoil, it is the central banks – not the politicians – that have served as the “adults in the room.”

FISCAL PRESSURES AND CRACKPOT SOLUTIONS

Similarly, the claim that the Fed is responsible for US fiscal deficits gets things exactly backward. In reality, the larger fiscal deficits implied by Trump’s proposed tax cuts pose a real danger to the Fed’s independence and represent the second threat to price stability.

The Committee for a Responsible Federal Budget estimates that Trump’s proposals would increase the federal deficit by nearly $7.8 trillion between 2026 and 2035, even after factoring in projections of increased tariff revenues. This increase would add to a deficit and national debt that are already at historic highs. If Trump successfully pressures the Fed to adopt his well-known preference for low interest rates, the money-printing myth could graduate from fiction to fact.

The antidote to fiscal recklessness is not to undermine the Fed. It is for the political branches of government to recognize the unsustainable trajectory of US fiscal policy, avoid exacerbating it, and pursue sensible tax and spending reforms. Regrettably, some in Congress – seemingly with Trump’s backing – are instead championing the embrace of cryptocurrency schemes that could weaken the Fed, boost the national debt, and destabilize financial markets. In October 2024, the Trump family launched its own cryptocurrency venture, World Liberty Financial, and began marketing tokens – so Trump’s financial self-interest, like that of some of his allies, is aligned with a crypto-friendly policy approach.

While political meddling in monetary policy and fiscal excess have long threatened price stability, this third component of Trump’s inflationary triple threat is unprecedented. The fundamental problem is that most cryptocurrencies, aside from stablecoins, are disconnected from the real economy and operate beyond the reach of public policy. Consequently, they introduce significant uncertainty into financial transactions, making them an unreliable foundation for economic decisions. Even stablecoins are only as good as the assets backing them.

Despite the numerous risks posed by an unregulated cryptosphere, its advocates continue to misrepresent the Fed’s solid track record to promote their agenda. Republican Senator Mike Lee, for example, has characterized the US dollar as “unstable,” owing to its alleged role in enabling the federal deficit, and has introduced legislation to prohibit the Fed from launching its own digital currency. If enacted, the prohibition would leave more room for unregulated cryptocurrencies, potentially facilitating illicit activities such as money laundering and terrorist financing. By providing alternative means of exchange, these cryptocurrencies could also diminish the Fed’s influence over the economy.

Likewise, Republican Senator Cynthia Lummis has cited “soaring inflation rates” and the national debt to justify her proposal to establish a “strategic Bitcoin reserve.” In her bill, Lummis claims that such a reserve would benefit the US government’s balance sheet, touting Bitcoin’s “resilience, widespread adoption,” and its role as a “medium of exchange and a store of value for more than a decade.”

Under Lummis’s plan, a reserve of one million Bitcoins would be dedicated to reducing the US national debt. The cost of acquiring cryptocurrencies, she claims, would be offset by “utilizing certain resources of the Federal Reserve System,” offering few specifics. What is clear, though, is that this plan would undermine the Fed’s balance sheet, limit its effectiveness, and expose American taxpayers to significant losses if and when the bet on Bitcoin fails.

The charts below show the extreme volatility of cryptocurrencies like Ethereum and Bitcoin compared to the supposedly “unstable” dollar and even to the more volatile S&P 500. Given their unpredictability, granting cryptocurrencies major monetary or financial roles would not enhance price or employment stability. On the contrary, it would almost certainly lead to greater instability. Integrating cryptocurrencies into the US financial system without stringent regulatory oversight is a surefire recipe for crises, recessions, massive government bailouts, and even larger public debts.

CASINO AMERICA

Despite these risks, Trump has endorsed Lee’s proposal to bar the Fed from launching a digital currency and supports the creation of a national Bitcoin reserve to purchase government debt. He has also vowed to loosen regulations to make the US “the crypto capital of the planet.” After all, what could go wrong with knee-capping the Fed while making the US financial system more like a casino?

To be sure, central banks are not perfect. Most advanced-economy central banks were slow to address the recent surge of inflation, waiting until 2022 to begin raising interest rates. By contrast, their counterparts in emerging markets acted earlier, stabilizing inflation expectations and benefiting from doing so before the Russia-Ukraine war intensified economic pressures.

Nevertheless, the decades-long track record of independent, inflation-targeting central banks is undeniably impressive, especially compared to what came before. This success explains why the model has become the global standard and why countries that eschew it, such as Argentina and Turkey, continue to grapple with high and persistent inflation.

The incoming Trump administration has pledged to pursue a series of inflationary macroeconomic and trade policies, including massive tax cuts, steep import tariffs, and mass deportations. In the face of such potentially destabilizing actions, the Fed’s credibility and robust oversight of financial markets are more critical than ever, yet both are now at serious risk.

More than a century ago, Keynes observed that during periods of high inflation, “all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless,” reducing the “process of wealth-getting” to “a gamble and a lottery.” Those words have never been more apt.

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Risk Warnings and Disclaimers

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Bruegel

Economic

One consequence of a major reform of the European Union’s emissions trading system in 2023 is that energy-intensive industries (EIIs) will ultimately be exposed fully to carbon pricing. In theory EIIs are subject to carbon pricing already but in practice they have received free allowances to shield them from the carbon price and protect them against foreign competition that is not subject to carbon pricing (and to prevent so-called ‘carbon leakage’ ). Free allowances allocated to many industrial sites consistently exceeded emissions during the third phase of the ETS (2013-2020), creating market distortions (De Bruyn et al, 2021).

The 2023 ETS reform thus plugs a loophole. However, some issues remain to be dealt with, including the treatment of EU exporters, the sectoral coverage of carbon pricing and the geographical misallocation of subsidies. This analysis discusses these challenges and suggests further steps that might be taken to ensure fair competition among EIIs within the EU and globally.

Industrial emissions and free allowances

We focus on three energy-intensive sectors – chemicals, basic metals and non-metallic minerals (ceramics, glass and cement) – that emit around 70 percent of industrial emissions covered by the ETS, while accounting for about 13 percent of EU manufacturing GDP (Figure 1; Sgaravatti et al, 2023) .

How to Fill the Remaining Gaps in Pricing the Emissions of the EU’s Energy-intensive Industries_1

Between 2013 and 2023, all ETS emissions fell by 36 percent, led by a 44 percent reduction in the power sector, while industrial emissions declined by just 17 percent. The slower progress in cutting industrial emissions can be attributed partly to free carbon allowances given to EIIs – a benefit the power sector does not receive (Figure 2).

How to Fill the Remaining Gaps in Pricing the Emissions of the EU’s Energy-intensive Industries_2

Because EIIs have received generous allocations of free allowances, a huge surplus has built up. Some excess allowances were sold, effectively acting as an industrial subsidy. For example, from 2008-2019, the cement sector gained up to €3 billion in extra profits because of over-allocation (de Bruyn et al, 2021). Moreover, as companies started to price-in the ETS price, they benefitted from windfall profits off the back of the free allowances.

Being shielded from the ETS carbon price meant EIIs had less of an incentive to decarbonise production, limiting their green investments in the past decade (2011-2020) to €7 billion per year on average (European Commission, 2024). From 2031-2040, decarbonising industrial production will require investment estimated at €46 billion per year (European Commission, 2024). More than 60 percent of this investment will be concentrated in chemicals, basic metals and non-metallic minerals (Table 1).

How to Fill the Remaining Gaps in Pricing the Emissions of the EU’s Energy-intensive Industries_3

Financing such investment could prove difficult if the current squeeze on EII profit margins, caused by high energy prices in Europe (Bijnens et al, 2024), continues.

Three remaining carbon pricing loopholes

Export competitiveness

The 2023 ETS reform reduces free allowances for some of the main products in the categories of basic metals (steel and aluminium), non-metallic minerals (cement) and chemicals (fertilisers and hydrogen). From 90 percent of their emissions in 2028, coverage by free allowances will fall to zero by 2034. Separately, from 2026, the EU carbon border adjustment mechanism (CBAM) will levy a carbon charge on imports of these products, to prevent carbon leakage.

EU exporters, however, will continue to compete on foreign markets with commodities not subject to carbon prices. EU exporters have thus called for an export carbon price rebate scheme. The annual cost of this could reach, by 2034, €4 billion for iron and steel and €7 billion overall (Table 2).

How to Fill the Remaining Gaps in Pricing the Emissions of the EU’s Energy-intensive Industries_4

The European Commission has ruled out export rebates, fearing they would undermine the EU’s climate goals and would risk conflicts with major trade partners. While this decision may be justified (Bellora and Fontagné, 2022), it does not address the issue of carbon leakage for EU exporters.

Sectoral coverage

Another issue is sectoral coverage and the risk of downstream carbon leakage. Since CBAM covers only certain categories of products, producers might relocate outside the EU and export into the EU products further down the value chain that are not subject to CBAM (eg machinery made of steel and aluminium). The risk varies greatly depending on the product. For example, green steel increases the final price of cars by just 2 percent (Dantuma et al, 2023), some plastics could see much higher price increases. We estimate that the price of the most common type of plastic, polyethylene, could increase by about 8 percent, for example .

Geographical misallocation of subsidies within the EU

Increased reliance on electricity to decarbonise production processes may shift investments from current EU industrial hubs to regions where electricity is cheaper because of the presence of renewable resources (such as hydro, wind and solar). Current electricity price disparities (Figure 3) favour Scandinavia and the Iberian Peninsula over central and eastern Europe, where most industrial production is located. As EIIs will be increasingly exposed to carbon pricing, governments might engage in subsidy races to retain incumbents, distorting the single market and nullifying the potential benefits of industrial reallocation – ie cheaper products for EU consumers, and more competitive firms on the global stage.

How to Fill the Remaining Gaps in Pricing the Emissions of the EU’s Energy-intensive Industries_5

Most green industrial subsidies are allocated at the national level, with the EU role limited to evaluating state aid applications.

Potential policy responses

While there are no easy fixes to the three challenges detailed above, they could be greatly mitigated by: prioritising public support for exporters, promoting carbon pricing and sectorial decarbonisation agreements globally, improving consistency in state aid, and pooling subsidies at EU level. We deal with each in turn.

Support for exporters

Exporters tend to be more productive than non-exporters (Wagner, 2007), so failing to address carbon leakage for exports could further harm EU industrial competitiveness. The EU could prioritise exporters in competitive bidding and grants for green subsidies, therefore offsetting the disadvantage they face globally, while supporting productive firms.

This could be done either through competitive bidding opened only to exporters, or by introducing qualifying premia for exporters in open auctions. Decarbonisation subsidies could target both capital costs and operating costs. The approach followed by the EU Hydrogen Bank , which subsidises only the additional costs required to make green hydrogen competitive (Kneebone and McWilliams, 2024), could be copied and adapted to specifically support EII exporters. However, operating cost subsidies should come with strict conditions and be time-limited, as they can disrupt the ETS, which is designed to ensure emissions reductions occur where costs are lowest. If not carefully managed, such subsidies could also place a heavy burden on public finances.

Additionally, lessons from the successful streamlining of permitting processes for renewable energy projects in designated areas could be applied to accelerate electrification in EII clusters focused on exports. Simplifying grid connection and permitting in these clusters would reduce delays and support faster decarbonisation.

Global persuasion

Among the major destination countries for EU CBAM exports (almost 80 percent of total value, Figure 4), several have introduced or are introducing carbon markets. The United Kingdom has its own ETS, Switzerland has linked its ETS with the EU, Norway is part of the EU ETS, China is expanding its national ETS to include EIIs, and Turkey, Mexico, Brazil and India are exploring carbon pricing systems. Canada has an advanced carbon market and Serbia and Ukraine are EU candidates, which implies a path of full convergence with EU rules, ETS compliance included.

How to Fill the Remaining Gaps in Pricing the Emissions of the EU’s Energy-intensive Industries_6

Though far from an easy diplomatic endeavour, advancing carbon pricing across the world seems to be a much better strategy than export rebates because it promotes the most promising tool for mitigating emissions, does not raise compatibility issues with World Trade Organisation rules, and leaves the incentive to decarbonise intact, including for EU exporters. Moreover, expanding carbon pricing globally reduces the risk of downstream carbon leakage.

A similar and complementary approach would be sectoral decarbonisation agreements, such as the Global Arrangement on Sustainable Steel and Aluminium (GASSA), creating carbon clubs for some EIIs. Finalising GASSA is particularly important given the importance of the United States as a destination market for EU aluminium and iron and steel exports, and the very remote prospect of full carbon pricing in the US.

Consistency in state aid

The EU should harmonise across countries the support given to energy-intensive firms to compensate them for higher electricity costs related to carbon pricing. Such support benefits currently from streamlined approval under state aid rules. Governments can use up to 25 percent of their national ETS revenues for this form of compensation. The EU could also introduce a floor level across all countries with considerable EII clusters, limiting the distortions by which EIIs in some countries receive much more compensation than in others. Conditions that have been introduced for this type of support, including energy efficiency measures and greening of production processes, make it more appealing and could justify its use to a greater extent than so far.

EU countries should also make more use of the top-up option for EU industrial subsidies, contributing their own financial resources . While this approach falls short of maximising efficiency (as funds are still earmarked on a national basis), it would be a great improvement on national auctions, by applying uniform allocation criteria and reducing administrative work by avoiding duplication across EU countries (Poitiers et al, 2024).

Pooling subsidies

In the medium term, moving to EU single-market mechanisms for subsidies would boost productivity and increase added value. Coordinated subsidies could increase power-sector productivity in Germany, France, Italy and Spain by 30 percent, closing 83 percent of the productivity gap with the United States and increasing added value by 6.7 percent (Altomonte and Presidente, 2024).

The European Commission has proposed increasing EU budget resources by withholding 30 percent of ETS revenues (European Commission, 2023). In 2023 the ETS raised €43 billion and by 2028 it could reach €65 billion (Saint-Amans, 2024) , compared to the overall green industrial investment needs of €46 billion per year. If the Commission’s proposal is accepted, it would mean additional EU budget revenues of €10 billion to €20 billion per year that could support industrial greening.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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SAXO

Economic

Why Rebalancing Matters

Over time, market movements can cause your portfolio's asset allocation to drift from its target. For example, if stocks outperform bonds, your portfolio might become overweight in equities, exposing you to more risk than initially intended. Rebalancing ensures that your portfolio remains aligned with your risk tolerance and investment objectives, providing stability in the face of market changes.

Timing Your Rebalancing

There are two common approaches to rebalancing: calendar-based and threshold-based.

Calendar-Based Rebalancing: This involves reviewing and adjusting your portfolio on a regular schedule, such as annually or semi-annually. It’s straightforward and helps maintain discipline without frequent trading.

Threshold-Based Rebalancing: This method triggers a rebalance when asset allocations deviate by a predetermined percentage from their targets. It can be more responsive to market changes but may require more frequent monitoring.

Both methods have their advantages, and the choice depends on your investment style and the amount of time you can dedicate to portfolio management. As year-end approaches, it's an ideal time for investors to consider rebalancing, regardless of the method chosen.

Steps to Rebalance Your Portfolio

Assess Current Allocations: Begin by reviewing your current portfolio allocations. Calculate the percentage of each asset class relative to your total portfolio value. Also do this for your regional, sectoral and thematic exposures.

Compare to Target Allocations: Determine how these current allocations compare to your target allocations. Identify any asset classes, regional, sectoral or thematic exposures that are over- or under-weighted.

Execute Trades: Adjust your holdings by buying or selling assets to bring your portfolio back in line with your target allocations. Be mindful of transaction costs and market liquidity when executing trades.

Document Changes: Keep a record of the changes made and the rationale behind them. This documentation can be valuable for future reference and maintaining a disciplined approach.

Case Study: Rebalancing a 60/40 Stock and Bond Portfolio

Initial Setup

On January 1, 2024, an investor begins with a $100,000 portfolio: 60% allocated to SPY, an ETF tracking the S&P 500 for stock exposure, and 40% in TLT, an ETF of long-term U.S. Treasury bonds for bond exposure.

SPY: $60,000;

TLT: $40,000

Year-to-Date Performance

As of 27 November 2024, SPY is up 27% YTD, and TLT is down 3%.

SPY New Value: $60,000 * 1.27 = $76,200;

TLT New Value: $40,000 * 0.97 = $38,800;

Total Portfolio Value: $76,200 + $38,800 = $115,000

Current Allocation

SPY: ($76,200 / $115,000) * 100 = 66.26%;

TLT: ($38,800 / $115,000) * 100 = 33.74%

Rebalancing Steps

To return to a 60/40 allocation:

Target SPY Value: 60% of $115,000 = $69,000;

Target TLT Value: 40% of $115,000 = $46,000

Potential Actions

Sell $7,200 of SPY ($76,200 - $69,000);

Buy $7,200 of TLT ($46,000 - $38,800)

By executing these trades, the portfolio realigns to its intended risk profile, demonstrating the importance of rebalancing to maintain investment goals.

Common Rebalancing Pitfalls

Investors may fall into several traps when rebalancing, such as:

Emotional Decision-Making: Allowing emotions to drive rebalancing decisions can lead to poor timing and suboptimal trades.

Neglecting to Rebalance: Ignoring the need to rebalance, especially during volatile markets, can result in unintended risk exposure.

Frequent Rebalancing: Over-rebalancing can lead to increased transaction costs and potential tax implications, reducing overall returns.

Ignoring Costs: Failing to consider transaction fees and bid-ask spreads can erode the benefits of rebalancing.

Inconsistent Strategy: Not adhering to a consistent rebalancing schedule or threshold can lead to haphazard portfolio management.

Focusing Solely on Asset Classes: Overlooking the need to rebalance within asset classes, such as sectors or regions, can lead to imbalances.

Market Timing Attempts: Trying to time the market when rebalancing can expose the portfolio to additional risk and uncertainty.

Avoiding these pitfalls can help maintain the effectiveness of your rebalancing strategy and support long-term investment success.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Goldman Sachs

Economic

Our economists forecast the UK’s GDP to increase 1.2% in 2025, which is slower than the Bank of England’s projection of 1.5% and just below the consensus estimate of economists surveyed by Bloomberg of 1.3%. The team forecasts 0.4% growth in the first three months of 2025 relative to the last three months of 2024, slowing to around 0.25-0.30% quarter on quarter in the rest of next year.

The British economy will be impacted by several key factors including uncertainty around trading arrangements with the US, a less expansionary budget, and proposed changes to the planning system for housing and development.

Our economists expect inflationary pressures to ease through 2025, introducing the potential for deeper interest rate cuts than the market has priced in. Market prices suggest the BoE will stop reducing interest rates at 4%, but our economists believe the central bank will continue cutting as far as 3.25%.

“We continue to think that the BoE will likely cut further than the market currently expects as measures of underlying domestic inflation fall back and demand comes in somewhat weaker than the Monetary Policy Committee’s latest forecast,” Goldman Sachs Research’s Chief European Economist Sven Jari Stehn writes in the team’s report, which is titled “UK Outlook 2025: A Gradual Pace, but More Cuts Than Priced.”

How will US tariffs impact the UK economy?

The UK’s trading arrangements will be a major focus next year. Uncertainty surrounding potential tariffs from the administration of US President-elect Donald Trump will likely weigh on confidence and is expected to notably reduce euro area growth. These tensions could also spill over into the UK, though probably to a lesser degree.

UK Economic Growth May Lag Expectations in 2025_1

Given the openness of the British economy, a global shift towards increased tariffs could hurt the country’s growth prospects. On the other hand, recent reports have indicated that the US may consider offering the UK a free-trade agreement in return for potential changes to food standards and greater market access for US healthcare companies.

The UK could also pursue closer ties with the EU: The government plans to strike a veterinary agreement, and Chancellor Rachel Reeves has hinted at regulatory harmonization in the chemicals sector. But the growth boost from these developments wouldn't be enough to meaningfully reduce the costs of Brexit, and it could run counter to closer trading relations with the US. UK Economic Growth May Lag Expectations in 2025_2

UK Economic Growth May Lag Expectations in 2025_2

The outlook for the UK budget

The UK’s autumn budget was more expansionary than expected, raising the prospect of stronger demand in the near-term. Even so, the updated plans still indicate consolidation in 2025, and growth is expected to cool in the second half of the year. The Office for Budget Responsibility will deliver a forecast update in the spring, which will be closely watched by markets.

“The government has left limited headroom against its new fiscal targets, and relatively small changes in the OBR’s macroeconomic forecasts could eliminate this headroom entirely,” Stehn writes.

Our economists think economic growth may prove lower than the OBR’s projections, increasing the chances that the OBR will revise its debt-to-GDP forecast upwards.

Planning reform could gradually boost UK GDP growth

The government also intends to reform the planning system for housing and development. Although it’s difficult to quantify the effect of the reforms without further policy details, our economists broadly expect the changes to result in a boost to residential investment over the next five years.

But the impact of any planning reforms on GDP growth over the medium term will depend on whether they increase labour productivity. A range of studies show that wages and productivity are higher in large cities, so relaxing planning restrictions could boost aggregate productivity by allowing urban areas to expand.

“Some studies have indicated that this effect could be sizeable in the very long run,” Stehn writes. “But we would expect any boost to productivity to occur gradually over an extended period of time.”

Inflation is forecast to ease in 2025

Inflation is expected to be firmer in the near term, easing throughout 2025. Public sector pay deals and government consumption following the autumn budget will support strong demand, while increases in vehicle excise duty and the introduction of VAT on private school fees could drive up prices in the services sector.

Nonetheless, Goldman Sachs Research sees domestic inflationary pressures falling back next year. Data from surveys conducted by the BoE suggest that tightness in the labor market is also likely to ease.

“This continued easing in labour market tightness — together with reduced catch-up effects now that inflation has returned close to target — are likely to result in a notable slowing in pay growth next year,” Stehn writes.

Reduced pay pressures are likely to result in services inflation declining gradually. This could lead to headline inflation undershooting the BoE’s latest projections: Our economists’ analysis puts headline inflation at around 2.3% in the final quarter of 2025, four-tenths below the BoE’s November forecast. They expect core inflation to fall to 2.5% by the end of next year.

The outlook for BoE rate cuts

Goldman Sachs Research expects the BoE to cut interest rates further and over a longer period than the market anticipates during this cutting cycle.

Our economists anticipate that the BoE will hold rates steady at 4.75% in December, given that inflation and growth are likely to remain firm in the near term. But with slowing inflation now likely in 2025, Goldman Sachs Research predicts quarterly cuts to interest rates throughout next year and into 2026, until the Bank Rate hits 3.25% in the second quarter of 2026.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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CEPR

Economic

The results of the recent US presidential election re-ignited a debate over the macroeconomic effects of tariffs, and the appropriate monetary policy response to a trade war. During the first Trump administration, US tariffs on Chinese exports rose seven-fold between 2018 and 2020, and they remained high under the Biden administration. More to the point, global political trends point to a significant weakening of global consensus regarding free trade and herald a new environment in which central banks may face this new type of shock with increasing frequency.

Much of recent research on the macroeconomic effects of trade policy shocks has been conducted in the context of real trade models, or in empirical exercises without consideration of monetary policy. But the consequences of trade frictions obviously challenge central banks: how should they respond to a backwards step in the progress towards increasing trade integration, with potentially significant effects on inflation, economic activity, external balances, and real exchange rates? In a recent paper (Bergin and Corsetti 2023), we study the optimal monetary policy responses to tariff shocks of various types. In this column, we update the analysis and distill lessons appropriate to the current situation.

In our paper, we study the optimal monetary policy responses to tariff shocks using a standard workhorse open-economy New Keynesian (sticky-price) model augmented with international value chains in production, i.e. imported goods are used in the production of domestic goods and exports. This implies that raising tariff protection of domestic exporters raises the cost of production for domestic firms. Throughout our analysis, we assume a share of imported inputs in production close to estimates based on the US input–output tables for 2011 (but we also verify our main conclusions varying this share). Our main analysis assumes substantial pass through of tariffs to consumer prices, but we also demonstrate robustness of our main results to enriching the model with a distribution sector that limits pass-through. Finally, we posit that monetary authorities do not take advantage of cross-border spillovers to pursue beggar-thy-neighbour policies, i.e. we rule out opportunistic manipulation of the exchange rate.

To sum up our main message: even if there is broad agreement that new Trump tariffs will likely be inflationary for the US, it is far from obvious that the optimal response of monetary policy to these tariffs should focus on fighting these inflationary effects via monetary contraction. Tariff shocks combine elements of both demand and supply disturbances, and monetary policy is bound to face a difficult trade-off between moderating inflation and supporting economic activity; in fact, a reasonable calibration of our model indicates that the optimal monetary response to such a scenario may well involve monetary expansion. Our analysis underscores that, while the optimal monetary response to tariffs depends on several factors, a key role is played by (i) the likelihood that the tariffs are reciprocated in a trade war, (ii) the degree of reliance of domestic production on imported intermediates, and (iii) the special role of the US dollar as the dominant currency for invoicing international trade. We discuss different cases in turn.

The case for monetary tightening: Unilateral tariffs without retaliation

Let us consider first the rationale for monetary tightening. This would be clear in a scenario in which the US unilaterally imposes a tariff on domestic purchases of foreign goods to boost demand for domestic goods, causing inflation in the price paid by domestic consumers and producers using imported inputs.

In Figure 1, we use our model to trace the effects of a unilateral tariff shock. The dashed lines trace the effect of such a shock over time while holding policy rates constant: GDP and inflation rise in the US, but they move in the opposite direction in the US’ trade partner (the foreign country). At the ongoing exchange rate, the US trade balance turns into a surplus.

Monetary Policy in Response to Tariff Shocks_1

Looking at these baseline results, a policy of monetary contraction at home (US) can be motivated by a need to moderate inflation – corresponding to monetary expansion abroad to moderate deflation. But a further motivation can be found in the fact that the divergence in the home and foreign policy stance works to appreciate the home currency, which can serve to lower the effective price of foreign goods that home consumers see, and thus partly offset the distortionary effect of the tariffs on relative prices.

These considerations underlie the behaviour of macro variables under the optimal policy, traced as a solid line in the figure. The US monetary authorities curb inflation, which in our case serves also to moderate the domestic rise in output. The fall in demand and the dollar appreciation reduce the trade surplus somewhat. Abroad, monetary authorities support activity at the cost of inflation, contributing to correcting in part the international relative price of goods distorted by the tariff.

As we show in our paper, the conclusions so far remain valid also when the degree of exchange rate pass through is low across all borders, i.e. prices are sticky in the currency of the export destination country. A low pass through reduces the effect of currency depreciation on relative prices, and monetary policy cannot rely on currency depreciation to redirect global demand towards own traded goods. Yet, in response to a unilateral tariff, the optimal stance is still contractionary at home and expansionary abroad.

The case for monetary expansions: Trade wars

Where our paper is more innovative is in showing that the optimal policy is generally expansionary in the case of a symmetric tariff war – say, if the foreign country retaliates with equivalent tariffs on imports of US goods. In this case, the US experiences not only higher inflation but also a drop in output, driven by the fall in global demand induced by the hike in trade costs. Trade wars present policymakers with a choice between moderating headline inflation with a monetary contraction, or instead moderating its negative impact on output and employment with a monetary expansion.

The trade-off confronting central banks is illustrated by the dashed lines in Figure 2, drawn for a symmetric war, under the assumptions that the pass through of the exchange rate on border prices is very high. The contractionary effects of the tariff war include a deep drop in gross exports worldwide. Inflation spikes, while output falls.

Monetary Policy in Response to Tariff Shocks_2

A trade-off between inflation and unemployment is obviously not unfamiliar to policymakers. If it were generated by a standard supply shock – say, a fall in productivity – standard macro models would suggest optimal policy would choose monetary contraction to stabilise inflation. However, as stressed in our analysis, tariffs are quite different from a standard productivity shock, in that they combine elements of supply shocks with demand shocks, and the optimal policy consequently tends to be quite different. One way to see this is that while a tariff war raises the average price of all consumption goods, including imports, the contraction in global demand tends to reduce the prices set by domestic firms. In other words, tariffs raise CPI inflation but tend to depress PPI inflation. In a retaliatory trade war, it is optimal to expand and stabilise PPI inflation despite the hike in CPI inflation hitting consumers. This is shown by the solid lines in Figure 2, drawn for one country (the conclusion applies symmetrically of course to all countries engaging in the trade war).

While we have demonstrated above that tariff shocks are quite different from productivity shocks, it is also important not to confuse tariff shocks with cost-push markup shocks. First, a home tariff shock only affects the prices of imported goods, while markup shocks are typically envisioned as affecting domestically produced goods. Second, the revenue generated by a tariff shock accrues to the importing country, while the profits from higher markups go to firms in the exporting country. Third, tariffs are imposed directly on the buyer, thus added on top of the price set by the exporter. Our model highlights the unique nature of tariff shocks relative to these other supply disturbances; even while monetary contraction is the optimal response to adverse productivity or markup shocks in the context of our model, monetary expansion is the optimal response to a tariff shock generating inflation.

Our analysis fully accounts for the fact that production in the US uses a high share of imported intermediate inputs, i.e. higher production costs amplify the supply-side implications of the tariff relative to the demand implications. Indeed, in our quantitative exercises, we find that the optimal response to a trade war becomes contractionary at a particularly high share of imported intermediate inputs in production. But based on input–output estimates of this share (and extensive robustness analysis in which we vary the share), we believe that our benchmark conclusion (prescribing an expansionary monetary stance) can be expected to be more relevant empirically.

The ‘privilege’ of issuing the dominant currency in international trade

The US dollar has a special role as the dominant currency used in international trade of goods. It is well known that if the prices of imports in all countries are sticky in dollar units, the US (the dominant currency country) can rely to a much larger extent on monetary policy as a stabilisation tool. That is, it should be in a better position to redress the distortionary effects of the tariff shock on own output and employment, with relevant implications for the rest of the world.

Consider first a tariff war, depicted in Figure 3 (again, the dashed lines trace the no-policy scenario, the solid lines the optimal policy scenario). On impact, the war is a global contractionary shock. In the dominant currency country, the optimal monetary response is now relatively more expansionary, as the national monetary authorities can redress the lack of global demand without feeding the inflation of imported inputs at the border – imports in dollars move very little with a dollar depreciation. An expansion in the dominant-currency country is good news for the other country: it contains the fall in global demand and reduces imported inflation there (a dollar depreciation means that importers abroad pay a cheaper price in domestic currency at the border). Because of this, even if the tariffs hikes are perfectly symmetric, the other country is in a different position. Rather than matching the expansion in the US, it resorts to a mild upfront contraction to contain inflation. Note that, while GDP falls in both countries, it falls by less in the country issuing the dominant currency. The US dollar depreciates in this scenario.

Monetary Policy in Response to Tariff Shocks_3

As we discussed above, in the case that the tariff is unilaterally imposed by the dominant currency country, the global demand for exports by this country does not suffer the effects of a retaliatory tariff. Hence, inflation becomes a more pressing concern for monetary authorities – the optimal stance is contractionary. The contraction can now be stronger, because the dollar appreciation has more muted crowding-out effects on US goods in the international market. The stronger contraction has global repercussions. Abroad the optimal stance becomes expansionary – to prompt domestic demand vis-à-vis falling exports to the US – tolerating inflation and exacerbating currency depreciation. The US dollar appreciates sharply in this scenario.

Conclusions

Tariff shocks may present policymakers with a particularly difficult choice between moderating inflation and the output gap. Several factors of the current situation suggest that, even while tariffs are likely to be inflationary, it might be optimal for policy to focus more on the inefficient fall in output. These factors include the likelihood that US tariffs could be reciprocated in a tariff war, the fact that current tariff threats seem centred more on final consumption goods rather than intermediate inputs in domestic production, and the fact that the US dollar has an asymmetric position in world trade as a dominant currency.

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Higher interest rates in recent years have sparked concerns about their adverse impact on clean energy investments. Such investments are needed to support the transition to a low-carbon economy, which is necessary to avoid further climate change damage to the economy. While higher interest rates typically reduce all types of business investment, there are worries that they may disproportionately hinder efforts to build renewable energy infrastructure and decarbonize the economy more generally.

Are higher interest rates particularly bad for green investment? To answer this issue, we compare whether equity prices of low-carbon “green” companies respond more to monetary policy surprises than those of high-carbon “brown” firms. Monetary surprises are measured using intraday changes in interest rates around monetary policy announcements. We also assume that financial investors price companies’ stocks based on their future investment opportunities and profitability. This methodology allows us to identify a causal linkage between interest rates and green financial prospects.

Our results reveal that monetary policy surprises tend to have a stronger impact on brown firms—those with higher carbon emission intensities—than on green firms. This finding suggests that rising interest rates may not skew investment away from the green transition. Given Europe’s well-defined and widely supported commitment to achieving carbon neutrality, our study uses European firm-level data and European Central Bank (ECB) monetary policy surprises. Using U.S. data, other recent studies have uncovered a similar greater sensitivity of the equity prices of brown firms to Fed monetary policy surprises compared with green firms. However, the deep social and political uncertainties surrounding U.S. climate policy may cloud investor perceptions and pricing of climate-related equity risks.

Our research contributes to a growing understanding of how monetary policy can affect the financial aspects of the green transition. We also explore potential reasons for the differing green/brown equity price responses. For example, an unexpected monetary tightening may increase the climate risk premium for brown firms, heightening their interest rate sensitivity. Additionally, investors with a preference for green securities may be less likely to substitute away from green stocks following monetary policy shocks. By contrast, our findings indicate that differences in other firm characteristics, such as leverage, age, and liquidity, have minimal influence on these dynamics.

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U.S. Economic Developments: Soft Landing Prospects

The U.S. economy continues to chart a path toward a "soft landing," a scenario where inflation cools without triggering a severe recession. Gradual easing in the labour market underscores this trend, with recent jobless claims figures showing minor increases yet remaining well below concerning thresholds. Businesses are largely retaining staff, indicating stable employment conditions.

This resilience supports the U.S. dollar, which has strengthened alongside rising bond yields. The USD Index, climbing to its highest level since October 2023, reflects this robustness. However, traders should monitor labour market data closely. Signs of accelerated wage growth or unexpected unemployment spikes could challenge the Federal Reserve’s policy outlook, impacting USD pairs.

Key Trading Insight: A firm USD amidst geopolitical uncertainty and stable economic conditions makes pairs like EUR/USD and USD/JPY attractive for traders seeking to ride the dollar's strength. Consider opportunities in these pairs while watching for inflation and employment updates that may signal reversals.

Eurozone Inflation Dynamics

Eurozone inflation is on the rebound, driven by energy price increases and moderate gains in core inflation. Headline HICP rose to 2.24% in November, with core inflation edging up to 2.74%. While food inflation has eased slightly, energy inflation has shown renewed strength, fuelled by base effects and higher energy costs.

Despite these increases, inflation remains uneven across components. Services inflation, particularly in labour-intensive sectors, shows signs of plateauing at elevated levels. The European Central Bank (ECB) faces the challenge of balancing rate stability with ensuring inflation remains near target levels. For traders, this dynamic introduces volatility in the Euro, especially against stronger currencies like the USD.

Key Trading Insight: The EUR’s vulnerability to inflation surprises and political uncertainty across the bloc suggests caution for traders. Pairs like EUR/GBP and EUR/USD may present opportunities tied to inflation data releases and ECB communications.

EURUSD H1 Chart

Japan’s Economic Challenges

Japan faces a precarious economic situation, with real GDP growth projected to contract by -0.3% in 2024. This negative growth outlook arises partly from premature rate hikes by the Bank of Japan (BoJ) amid a global slowdown, which has dampened domestic demand. Real consumption remains below pre-pandemic levels, highlighting persistent economic fragility.

Inflation trends also raise concerns. The core consumer price index (CPI), excluding fresh food and energy, is showing only modest growth, far below the BoJ’s 2% target. Market expectations for further BoJ rate hikes in December could boost the Yen temporarily, but sustained weakness in domestic demand may limit its upside.

To counter deflationary risks, the Japanese government has unveiled aggressive fiscal measures, including a JPY21.9 trillion stimulus package, tax adjustments, and economic incentives ahead of next year’s elections. However, these measures may take time to filter through, keeping the Yen in flux.

Key Trading Insight: With the USD/JPY pair influenced by diverging monetary policies and Japan’s domestic challenges, traders should watch for BoJ rate announcements and macroeconomic data. Short-term bullish bets on the Yen could align with expectations of tightening, while long-term positions may favour the dollar's resilience.

USDJPY H1 Chart

How Global Economic Shifts Shape November's Trading Opportunities_2

Energy Markets and Commodity Currencies

Energy markets are experiencing renewed turbulence, driven by geopolitical tensions and shifting supply dynamics. Oil prices have risen on reports of escalating conflict in Eastern Europe, with West Texas Intermediate (WTI) crude climbing above $70 per barrel. Such developments often bolster commodity-linked currencies like the Australian dollar (AUD) and Canadian dollar (CAD).

The Australian dollar, for instance, has gained modestly due to higher energy commodity prices and strong yield support. However, the Reserve Bank of Australia (RBA) has delayed its anticipated rate cut timeline to mid-2025, suggesting a cautious stance that could temper AUD strength.

Conversely, the Canadian dollar faces mixed prospects, with oil prices offering support but domestic economic concerns weighing on long-term growth expectations. Traders should also consider how China’s economic policies—particularly in energy demand and industrial output—may affect commodity currencies broadly.

Key Trading Insight: Pair movements such as AUD/USD and USD/CAD offer opportunities tied to energy price shifts. Stay attuned to geopolitical news and central bank guidance, as these can trigger rapid market re-pricing.

AUDUSD & USDCAD H1 Chart

Key Market Movements and Trading Opportunities

Recent forex market trends highlight areas of volatility and opportunity:

USD Strength: The U.S. dollar continues to benefit from robust economic fundamentals and rising bond yields, making it a preferred choice during geopolitical uncertainty.

US10YJPY Volatility: Expectations of a December BoJ rate hike has strengthened the Yen, but longer-term challenges may cap its gains.

BOJ Hike ExpectationsEUR Pressures: Inflation dynamics and uneven economic growth across the Eurozone add complexity for the Euro, offering tactical trading opportunities.Commodity Currencies: The AUD and CAD remain closely tied to commodity price movements, with geopolitical risks adding further unpredictability.

AUDUSD (Blue), USCAD (Pink) & GOLD Prices (Purple) Daily Chart

Actionable Strategies:

Focus on pairs like USD/JPY for short-term volatility tied to BoJ decisions.Monitor EUR/USD for potential moves driven by inflation and ECB policy updates.Trade AUD/USD and USD/CAD in line with energy market developments and RBA/BoC communications.

The U.S. dollar stands firm amidst steady economic performance, while the Euro and Yen face contrasting pressures from inflation and growth uncertainties. Meanwhile, commodity currencies like the AUD and CAD remain sensitive to energy markets and central bank strategies.

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Trump’s Inflationary Triple Threat

PLAYING WITH FIRE

FISCAL PRESSURES AND CRACKPOT SOLUTIONS

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How to Fill the Remaining Gaps in Pricing the Emissions of the EU’s Energy-intensive Industries

Industrial emissions and free allowances

Three remaining carbon pricing loopholes

Potential policy responses

Support for exporters

Global persuasion

Consistency in state aid

Pooling subsidies

Portfolio Rebalancing: A Key Pillar of Financial Wellness

Why Rebalancing Matters

Timing Your Rebalancing

Steps to Rebalance Your Portfolio

Case Study: Rebalancing a 60/40 Stock and Bond Portfolio

Common Rebalancing Pitfalls

UK Economic Growth May Lag Expectations in 2025

How will US tariffs impact the UK economy?

The outlook for the UK budget

Planning reform could gradually boost UK GDP growth

Inflation is forecast to ease in 2025

The outlook for BoE rate cuts

Monetary Policy in Response to Tariff Shocks

The case for monetary tightening: Unilateral tariffs without retaliation

The case for monetary expansions: Trade wars

The ‘privilege’ of issuing the dominant currency in international trade

Conclusions

Green Stocks and Monetary Policy Shocks: Evidence from Europe

How Global Economic Shifts Shape November's Trading Opportunities

U.S. Economic Developments: Soft Landing Prospects

Eurozone Inflation Dynamics

Japan’s Economic Challenges

Energy Markets and Commodity Currencies

Key Market Movements and Trading Opportunities

Actionable Strategies:

Risk Disclosure