Spectre of inflation could keep Donald Trump in check

In a mere ten days, we witnessed Donald Trump sweep the swing states and win the popular vote, and the Republicans secure both the Senate and the House of Representatives. On the face of it, you could be forgiven for thinking the most potent political pushback that the president-elect is likely to encounter in office will be indignant tutting and whiny opinion pieces.
It might also seem like the Labour Party has the same “powerful mandate” as Trump, and the same freedom of manoeuvre, after its own landslide victory.
The difference, however, is that Sir Keir Starmer’s cabinet possess about as much buccaneering elan as a group of semi-retired provincial librarians. By contrast, Trump is advised by a billionaire who views Mars as within pretty easy reach. In other words, it’s unlikely the new US administration will temper its ambitions due to a sudden onset of political stage fright.
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Questions abound on what will remain campaign rhetoric and what will become reality, and to what extent the opposition can prevent Trump from carrying out his proposals.
In particular, we look set for radical changes to trade tariffs, immigration and red tape. The market reaction last week indicated not only relief that political uncertainty has abated, but also an expectation that election trail commitments will be followed through.
The immediate drop in European stocks, and the euro’s fall of more than 3.5 per cent against the dollar since the election, suggest markets are predicting early and biting tariffs. Equally, the share prices of US banks soared after the Republican victory, with investors anticipating that the president-elect will make good on his pledges to deregulate the sector, slashing the amount that financial institutions are required to hold and loosening rules around mergers.
But my suspicion with Trump’s flagship policy ambitions is that we will ultimately get a diluted version of what has been promised. To my mind, the spectre of inflation is the underestimated factor that could rein in the administration’s plans.
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US inflation hit 2.6 per cent last month, suggesting that it is stabilising somewhere near, but still above, the Federal Reserve’s 2 per cent target. The new administration is inheriting an economy where the cost of living has been moving — albeit gradually, and possibly unevenly — in the right direction.
The economy was one of the biggest factors in the Republicans’ election victory. It was also an issue on which Trump consistently scored markedly higher than Kamala Harris.
Although, on many metrics, the economy has performed well under President Biden, the after-effects of soaring inflation have left Americans struggling under the weight of elevated prices.
Trump must know that the perceived success of his presidency will hang partly on low inflation and robust growth. At the outset, the last thing his team will want is an inflation spike, particularly as this would make the US an outlier among other major developed economies.
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Whichever way you look at them, reduced immigration and soaring tariffs will be inflationary forces.
High labour supply has so far kept wage growth in check and prevented the US economy from overheating. This was one of the primary reasons why the Federal Reserve felt comfortable with its decision to start reducing interest rates. Trump’s campaign rhetoric around drastically curtailing immigration, not to mention the proposal of mass deportations, would reduce the size of the labour market and create a more expensive workforce.
Equally, while it may look as though tariffs will improve the US economic picture to begin with, those increased costs are likely to be passed straight back to American consumers and eventually hit take-home pay. Over the summer, a group of Nobel-winning economists warned that Trump’s tariff proposals would reignite inflation, with the Peterson Institute for International Economics estimating that they would cost the average American household an extra $2,600 (£2,000) a year.
And if inflation makes a comeback, it’s not just US households who will feel short-changed as a result of these policy initiatives. Markets are likely to have their own tantrum; higher prices for consumers created by rising labour costs and import duties amount to inflation unaccompanied by growth, a toxic brew for investors already worried about a slowing economy.
My best guess would be that inflation will hover as a ghostly warning to the incoming administration, an ever-present reminder that overreaching can come with serious consequences.
When you have been elected on a promise to raise living standards and make people feel richer, it could turn out much harder to be populist in practice.
Seema Shah is chief global strategist at Principal Asset Management