By Carmel Crimmins

Feb 5 (Reuters) -

The rout ripping through stock and credit markets this week is jaw-dropping in its scope – nearly $1 trillion in market value wiped out. But surely the direction of travel is not a surprise. We’ve been talking for years about how artificial intelligence $(AI)$ is going to change the world. There were always going to be losers as businesses – and their financial backers – get upended.

The spark – a new tool released by Anthropic that automates swathes of marketing, legal and sales work – is a warning shot for professional services industries that sell their own software products. Is the market overreacting? Possibly, but there is no doubt that industries and their employees have been put on notice.

The big fear is what this could all potentially mean for the labor market. Anthropic CEO Dario Amodei has warned that AI innovation, in the short term, will cause “unusually painful” disruption to jobs.

The other side, of course, is the impact on productivity. If a task requires less hours worked, and fewer workers, it will boost productivity and economic growth. Doing more with less also eases the need to raise prices, helping to fight inflation. An AI-inspired boost to productivity is one of the main arguments Fed chief nominee Kevin Warsh uses to call for further interest rate reductions, even with inflation still about a percentage point above the central bank's 2% target. Warsh’s plans for the Fed and how they may pan out are the topic of this week’s Reuters Econ World podcast with our Fed correspondent Howard Schneider. Catch it here.

U.S. worker productivity is rising - it grew at its fastest pace in two years in the third quarter - and is a factor behind what economists are calling a jobless economic expansion. And as my colleague, Reuters columnist Jamie McGeever points out, America’s productivity boom may be spreading. Britain, long a laggard in the productivity stakes, is showing signs of life. Recent purchasing managers' index figures show British business activity kickstarting this year on a strong footing, with robust demand at home and abroad spurring the fastest output growth since April 2024.

Will British Prime Minister Keir Starmer reap the benefits of these economic green shoots? His premiership is in crisis over his decision to appoint Peter Mandelson as UK ambassador to the United States despite knowing about his ties to Jeffrey Epstein. The pound and British bonds are rattled by the crisis, with UK borrowing costs rising. If Starmer - and possibly his finance minister Rachel Reeves - were replaced, markets are unsure whether a new Labour leader would stick to the government's current borrowing limits.

And speaking of politics and markets, a decisive win for Japan's ruling Liberal Democratic Party $(LDP)$ at Sunday's election may be the best outcome for bonds and the yen, analysts say, even as Prime Minister Sanae Takaichi's spending pledges have repeatedly rocked markets.

An overwhelming LDP victory would eliminate the need for Takaichi to negotiate with opposition parties, who are touting even deeper tax cuts and broader fiscal spending.

THE HEADLINES

• 'Software-mageddon' leaves investors bargain-hunting but wary

• Exclusive: Justice Department unit on police misconduct sees staffing plunge and probes scaled back, sources say

• Google goes from laggard to leader as it pulls ahead of OpenAI with stellar AI growth

• US and Iran agree to Friday talks in Oman but still at odds over agenda

THE CHART

The Fed's favored measure of inflation - core personal consumption expenditures (PCE) inflation, which excludes volatile food and energy prices - is creeping higher again, and several alternative gauges of retail prices also show some heat building as 2026 is getting underway.

THE PODCAST

“Short-term interest rates, long-term balance sheet, those are going to be the two guiding stars. If you are looking for a tell about the Kevin Warsh chairmanship, those are the two things to think about." Federal Reserve correspondent Howard Schneider on the latest episode of Reuters Econ World podcast. On this week's show, we look at what President Trump's Fed chair pick wants changed at the U.S. central bank and how things may work out if Kevin Warsh is confirmed as Jerome Powell's successor. Listen now.

THE REAL WORLD

• Zurich/London: Epstein files show Swiss bank CEO de Rothschild kept up years‑long personal contact with financier

• Palo Alto: Musk's mega-merger of SpaceX and xAI bets on sci-fi future of data centers in space

• San Francisco: Google goes from laggard to leader as it pulls ahead of OpenAI with stellar AI growth

THE WEEK AHEAD

• Feb 8: Elections in Japan

• Feb 11: U.S. nonfarm payrolls

• Feb 13: U.S. inflation

(Editing by Catherine Evans)