UBS On-Air: Paul Donovan Daily Audio 'Threats and freezes'
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Good morning, this is Paul Donovan, Chief Economist at GBS Global Wealth Management. It's 7 o'clock in the morning London time on Wednesday the 22nd of January. UK public sector borrowing increased in the month of December. The big driver behind the increase was an increase in the retail price inflation measure, which is vaguely tied to the rate of inflation. This raises the cost of inflation-linked gilts.

Inflation-linked gilts will stop being linked to the retail price inflation measure at the end of the decade, as statisticians do not regard this number as being reliable. Increases in things like energy costs, which are themselves a function of government policy in the UK, thus pass through to higher government borrowing costs, raising public sector borrowing. The World Economic Forum gathering in Davos always allows for a certain amount of chatter from policymakers.

It also allows for economists to pontificate in blogs. Yesterday, ECB governing council member Nott essentially endorsed market expectations for January and March rate cuts, but also was suggesting that a monetary policy stimulus was not needed. Many investors would dispute that, and there is a sense that the ECB's current policy is too restrictive.

US President Trump has suggested imposing a 10% tax on US consumers of imports from China on the 1st of February. That would be in addition to the threats of a 25% tax on consumers of Canadian and of Mexican goods. At this point, it's probably not worth tracking every single threat, as Trump has not necessarily followed through on their threats in the past. In general terms, therefore, there are three key points to make.

For every 10% tariff applied at the point of import, US consumers should expect to see a 4% increase in the price of that imported good in their stores. The main inflation threat is less the direct tax and more the second round effects. US companies raise prices as they face less competition, hiding behind import taxes, and retailers indulge in profit-led inflation.

Finally, selective tariffs against a specific country can be avoided through supply chain rerouting. And up to a third of China's exports to the US do this, though that would be a lot harder to achieve for Canada and Mexico. These points mean that the full effect of Trump's tax threats may be more than a simplistic model on imports would suggest, but it may take longer for the inflation effects to be felt.

Trump has also frozen something over $300 billion in contracted payments and loan guarantees for infrastructure investment. This, in the short term, is probably a very modest negative for economic growth, as economic activity will presumably slow, or indeed halt, in the face of uncertainty about funding and loan guarantees.

In the longer term, the effect is more likely to be redistributing growth than simply stopping it. Paying lawyers to argue contracts in the courts is a form of economic activity. Whether it's a form of economic activity that is as productive as building infrastructure is a different issue. The overall effect on the US budget deficit is likely to be quite limited. That's all for today. Have a good day.

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