Rates Hop, Skip, and Jump
The week began with AI investors waking up to the success of China’s DeepSeek in matching the performance of OpenAI’s GP4-o1 at a fraction of the build cost and despite export restrictions. Innovating a more productive use of capital does not negate the potential gains from increasing processing power. Either way benefits the economy with faster AI progress. We highlighted that foundation model IP needs better protection against the attack of cloning distillation techniques to reap a return on investment while pushing the performance frontier (see AI: Attack Of The Clones).
Even if the solution to preserving return on AI investment is down to a few companies, the US government will be vexed by this result. It will probably be emboldened to continue its tech war with China, not that it’s the only tension in Donald Trump’s inbox. Alastair Newton believes Russia’s economy alone will not bring Vladimir Putin to the negotiating table over Ukraine, even if Donald Trump follows through on his threats. But we may still see a deal this year. This would be good news for European equities (see Russia, Ukraine and Trump’s Legacy).
UK political stories have focused more on Labour’s new long-term growth plans that are worthy but lack short-term impact, as infrastructure and investment projects take years to deliver economic benefits. Despite policy rhetoric, the UK economy is structurally struggling, with GDP stagnation, persistent inflation, and fiscal constraints limiting immediate growth prospects. Political motives overshadow immediate economic substance, as ambitious projections serve electoral strategy rather than offering near-term economic transformation (see UK: Political Policy Spectacle).
Statist fiscal policy has also been contributing to the inflationary pressure in Brazil, where the policy rate was hiked by another 1pp, with a third such move signalled for the next meeting. It typically leads the Fed by a year, so this ongoing hawkish turn remains consistent with our view of a 1998-style reversal in 2026. The Fed unsurprisingly paused its cutting cycle, as did Chile, while 25bp cuts in Canada and Sweden seem set to be some of their last.
The ECB cut its deposit rate by 25bp for the fifth time as growth remains weak, with GDP stagnating and inflation still expected to ease towards target-consistent levels. It believes monetary policy is tight despite 125bp of easing, leaving room for another cut in March. Updated staff estimates of the neutral rate on 7 February are critical. However, President Lagarde rejected calls for a stimulative policy with an incredulous tone. Low unemployment suggests output isn’t below potential, making stimulus inappropriate (see ECB: Nearing Neutral Updates).
Monetary policy is more contentious in the UK, although the 6 February outcome seems no less inevitable than the Fed or ECB’s were. Three dovish dissenters in December have already created significant momentum towards that cut. UK unemployment has increased while some activity surveys have softened, allowing the BoE to point to these dovish developments as justifications for another cut. Wage growth has been awkwardly high, but most MPC members are comfortable assuming unemployment will break these excessively inflationary pressures. We expect two MPC members to dissent against this rate cut ahead of holding rates steady again in March.
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