Article last updated 12 August 2025.
Quick take:
- The Bank England narrowly voted for a quarter-point interest rate cut
- US tariffs are likely to boost domestic inflation and impose costs on businesses and consumers
- We favour shorter-dated UK and US government debt because of inflation and fiscal concerns
- Japanese exporters’ profits could be hit by US tariffs, but there’s much to like about Japanese stocks
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What connects the Men’s High Jump in the 2020 Tokyo Olympics, the crazy golf match between Bart and Todd Flanders in The Simpsons and last Thursday’s August interest rate decision by the Bank of England’s nine-strong Monetary Policy Committee?
The answer is that all these events resulted in a draw.
The mathematically minded will be wondering how a draw can emerge from a decision made by nine voters. The solution to this puzzle is that there were actually three results. Four Committee members, including the Bank’s Chief Economist, Huw Pill, voted to keep its benchmark rate unchanged at 4.25%. Another voted to cut by a quarter of a percent. The ninth, Alan Taylor, opted for a dramatic half a percent cut. In contrast to the high jumpers and the protagonists of The Simpsons, for the Bank of England there was a quick resolution to the impasse. In an unprecedented second round of voting – the only time the Committee’s had to do this in all its 28 years – Taylor trimmed his suggested cut to 25 basis points to get a new benchmark rate of 4% over the line.
It's a measure of the uncertainty over the UK economy that Committee members entertained not a mere two but three options. This reflects the twin realities of economic weakness and inflationary pressure.
Slacker UK labour market
The quarter-point camp noted a slacker labour market. UK payroll employment has fallen for five straight months, pushing unemployment up to 4.7%. This has contributed to slower wage growth – people are less likely to bargain hard over starting salaries or pay rises when they sense it might be harder to find an alternative job. People’s average earnings rose 5% in the three months to May, down from a December peak above 6%. Easing wage growth reduces inflationary pressure, by keeping a lid on companies’ costs.
The one-man half-point camp – Mr Taylor – adopted a gloomier tone, even mentioning the R word. “UK sentiment was weak, with subdued consumption and investment”, reads his argument in the minutes of the Committee meeting. “This picture was one of downside risks in coming years, namely: inflation below forecast, and activity weak or an increased risk of recession.” Taylor recommended the half monty of a half-point cut as “insurance” against these risks.
Finally, the stay-as-we-are camp cited high inflation expectations among both businesses and ordinary people, including rising inflation for food and energy. These are two types of inflation that can be particularly crucial in setting ordinary people’s inflation expectations because they’re so visible. It’s hard to feel that inflation is coming down when the price of chocolate bars in Aisle Seven has risen so fast (sweets and chocolates are up 9.9% in the year to June, according to official figures). Higher inflation expectations tend to become self-fulfilling: they influence how hard people bargain over their wages, for example.
It's revealing that after the vote at the Old Lady of Threadneedle Street – an affectionate sobriquet for the Bank – financial market expectations in the surrounding City of London of the likely interest rate at the end of this year actually rose rather than fell. Markets were previously pricing in a 90% chance of another quarter-point cut this year. After the news, they were less certain, pricing in a 75% chance.
It’s partly because of concerns about inflation that we favour shorter-dated UK government bonds (known as ‘gilts’). Debt with longer maturity is more sensitive to changes in expected inflation. We also worry about the difficulty the government will face in cutting the fiscal deficit – the gap between the government’s income and its spending. This is a further reason to favour shorter-dated over longer-dated debt, which is more sensitive to fiscal problems. That said, Britain’s fiscal deficit is considerably less than in many other advanced economies. Moreover, looking to what might happen to the deficit in the future, Chancellor Rachel Reeves is showing every sign of fiscal conservatism – more than the US administration, for example.
Tariffs: the domestic cost
Across the Atlantic, US President Donald Trump sees greater income from tariffs as one way of reining in the US’s enormous fiscal deficit.
The government collected nearly $30 billion in tariff revenue last month, according to the Treasury Department. That’s a 242% jump compared to last July.
But when considering how tariffs might reduce the deficit, we also have to take into account the likely hit from tariffs to the US economy, and therefore to the tax revenue that dictates how the deficit’s size.
We also believe that the cost of tariffs will largely be borne not by exporters reducing their profit margins, but by US businesses and consumers. That will reduce corporate profits and put pressure on household budgets. We expect this to begin showing up in US inflation figures for September or October. It’s not just the cost that’s hard for businesses – it’s also the uncertainty over what their costs will be.
Just as for gilts, we favour shorter rather than longer-dated US government debt because of the outlook for inflation and the fiscal deficit.
The latest nasty tariff surprise was last Wednesday’s news of an additional 25% on US imports from India, bringing the rate to 50%. This was prompted by Trump’s pique at the country’s large purchases of Russian oil at a time when Trump is angry over what he regards as Russian President Vladimir Putin’s foot-dragging over negotiations to end the war in Ukraine.
That said, we do still see plenty of opportunities in US stocks – we have more investments in the US market than any other. Supporting this sense of ongoing attraction, the US quarterly corporate earnings season continued last week to produce plenty of nice surprises, where companies beat analysts’ expectations.
Driving away profits
Exporters to the US will bear some of the pain of tariffs, though, as well as US businesses and consumers. Bearing this out, last week Toyota, Japan’s biggest carmaker, downgraded its full-year profit forecast by 15% after predicting a ¥1.4tn ($9.5bn) hit this year from US tariffs. The latest rate on auto exports to the US is, at least, down from a previously threatened 27.5% to 15%.
Despite this, we do see compelling opportunities in Japanese stocks.
Japan is an export-oriented economy and tariffs are a headwind. But its stock market has other drivers and has done relatively well since Liberation Day on 2 April, when Trump announced sweeping tariff plans. The country’s pedigree of technological excellence sees no sign of disappearing and companies are becoming more shareholder-friendly.
Moreover, the return of inflation over recent years is both painful and helpful. Anyone sitting down with a bowl of rice to watch TV will have paid a lot more for it than when they settled down to watch the Tokyo Olympics over dinner. The price of this staple food has doubled in Japan over the past year, due to pestilence, heatwaves, speculation and policies that make it difficult to smooth out the effects of domestic imbalances of rice supply and demand.
Rocketing staples prices could cost the reform-minded government in upcoming elections, something we’re monitoring closely. But counterintuitively, general inflation is good on balance for the domestic economy. It encourages consumers and businesses to spend now, rather than putting off purchases till tomorrow in the hope that the price of that cutting-edge new rice cooker, which produces just that soupçon of extra fluffiness, will fall. This is a welcome change from the deflationary trap Japan was in during the 1990s and 2000s.
