Inflation is falling because the economy is on its knees

Inflation is falling because the economy is on its knees 2025 has been the year of Rachel Reeves – although not in a favourable way Daily Telegraph 22/12/25 Since 2025 is not yet done, it may seem a trifle early to be writing its overall assessment. But next week, in that strange interregnum between Christmas and New Year, I intend to cast my eye forward to the coming year. So this is my last chance to comment on the one almost over.

Living in the UK, you might reasonably surmise that this has been the year of Rachel Reeves – although not in a favourable way. Yet, thinking globally, the person who has dominated 2025, economically as much as in other spheres, is surely Donald Trump. He has been active all year in trying to bring about an end to the Russia-Ukraine conflict. He may yet pull off something spectacular after this article has gone to print. But, although this would bring much-needed relief in many quarters, I doubt that it would have major economic effects – either globally or here in the UK. On economic matters, president Trump has caused consternation around the world by announcing a series of “reciprocal” tariffs which differed very significantly between one country and another. And he had a habit of reducing them and sometimes increasing them again, apparently at the drop of a hat. This played havoc with the confidence of businesses, not just in the US but also globally. The really striking thing, however, is that, so far at least, the imposition of tariffs has apparently not caused the US economy any serious problems. True, inflation remains somewhat elevated but it hasn’t been driven sharply higher by the increased costs implied by tariffs. Indeed, the latest figures showed a sharp drop. Meanwhile, a shortage of labour, partly brought about by president Trump’s immigration controls and mass deportations, appears not to have caused the real economy any serious difficulties. In 2025 the economy grew by just over 2pc. And in the non-financial corporate sector, productivity growth seems to have been about 3.5pc. There are those who see this as the direct result of artificial intelligence (AI). Indeed, AI has been one of the major themes of the year. Of course it has been the overwhelming force behind the boom in the American stock market, with the seven largest stocks – the so-called Magnificent Seven – being responsible for about 35pc of the value of the S&P 500. Plenty of good judges are worried that the AI stock market boom is a bubble, reminiscent of what happened in the dotcom crash of 25 years ago. They may well be right eventually, but there is no compelling reason to believe that a bust is due anytime soon. In any case, history suggests that the economy can withstand the effects of a bust in the stock market. It is property market collapses that cause serious problems because of their effects on the banking system. And there’s no sign of that in the US. But there are currently other worries in the financial system – not least in the shadowy, unregulated world of private credit. Over here, the year is ending much as it began, with anxiety about the impact of tax rises and other government actions on business costs and employment, as well as concerns about the level of government spending and borrowing. It would be comforting to believe that the continued drop in employment recorded in the UK during this year has been largely a response to productivity increases brought about by AI. Sadly, though, I suspect government impositions such as the increases in National Insurance, the higher minimum wage and the impending disaster of the Employment Rights Act have had much more to do with it. Throughout the year, inflation has been a lingering worry, restricting the scope to reduce interest rates. By the end of the year, however, it was in retreat. The Chancellor received two early Christmas presents last week with the unexpected fall in inflation to 3.2pc and the subsequent cut in Bank Rate to 3.75pc. This being economics, however, such presents come with the cost of purchase shown on the gift. Inflation is falling so fast because the economy is flat on its back. Meanwhile, although the gilt market had undergone several flurries of anxiety during the year, by the end – with inflation and interest rates apparently set to fall – gilt yields had edged down. There was no sign of the gilt market strike that some analysts had feared. This is not to say that the fiscal position looks comfortable. Far from it. Last year, about three quarters of the Government’s borrowing was made to finance interest payments on the debt created by previous government borrowing. At least we are not alone in our fiscal predicament. The American fiscal position is worse and, closer to home, France looks to be in a serious pickle. Not only is its debt ratio and deficit higher than ours, but it appears to lack the political will to do anything about it. In Germany, by contrast, the fiscal position is much better thanks to decades of extremely conservative fiscal policies, which are now being relaxed. But Germany faces severe structural problems. The country of economic miracles seems to be operating an analogue model in a digital world. This may tempt you to add a dollop of schadenfreude to your Christmas indulgences. But German economic weakness doesn’t do us any favours. We need the European economy to be strong to provide good markets for our exports. I don’t suppose that many people will regret the passing of 2025. But, as you tuck into the festive fare, perhaps you can comfort yourself with the thought that it could all have been a whole lot worse. Please don’t risk your digestive comfort by worrying that this may be exactly what lies in store in 2026. You have a week’s respite before I reveal my prognostications about the good, the bad and the ugly in the year ahead.