Economic outlook: what might 2025 have in store?

In this month’s commentary, our Chief Economist, Colin Warren, explores the economic outlook for 2025, focusing on growth, inflation, and interest rates across the US, eurozone, and UK.

2024 was another year when the implausibly-precise forecasts of economists and financial analysts proved wide of the mark. The US economy outperformed consensus expectations, avoiding the slowdown many predicted. Partly as a result, core inflation proved stickier than had been hoped, and interest rates did not fall as sharply as was generally anticipated[i].

Looking ahead, the outlook for 2025 is arguably more uncertain than that for 2024 was this time last year. President-elect Donald Trump’s policy proposals (including tariffs, deregulation, tax cuts and curbs on immigration – see our commentary of September 2024[ii]) could profoundly influence prospects for growth and inflation, both in the US and globally. However, the precise impact will depend on the policy detail and the sequencing in which measures take effect.

This elevated policy uncertainty in the world’s largest and most influential economy has not deterred economic forecasters from trying to foresee what will happen during the year to come. In this commentary, we look at the outlook for growth, inflation, and interest rates in 2025 in the US, the eurozone and the UK. 

Strong momentum in the US

In 2024, growth in the US outpaced that in other developed economies, including the eurozone and the UK, and is on course to repeat the feat in 2025. With the economy expanding at an above-trend clip during the final months of the year and business optimism improving in the wake of Trump’s election victory[iii], the world’s largest economy has entered the new year with a high degree of momentum.

The fading impact of the pandemic stimulus measures (excess household savings are now close to being depleted[iv]), the lagged effect of earlier monetary tightening, and a cooling labour market might cause growth to ease somewhat in 2025. However, with US household wealth at record highs[v], debt servicing costs manageable[vi], and wage growth likely to outpace inflation, household consumption can be expected to continue to drive the expansion. Furthermore, improved business confidence and increased tech spending (not least in AI and related industries) bode well for stronger investment in 2025.

Trump policy uncertainty

The consensus looks for 2.2% US real Gross Domestic Product (GDP) growth in 2025, with most forecasts in the 1.9-2.5% range[vii]. However, the policies of the incoming Trump administration pose an obvious downside risk to the outlook. If Trump imposes sweeping tariffs on day one of his presidency as he has threatened (see our commentary of December 2024[viii]) growth could take a hit via its impact on real incomes, supply chains, and sentiment. The overall impact will depend on precisely what levies are imposed. As a rule of thumb, Goldman Sachs supposes that a one percentage point increase in the US effective tariff rate (i.e. the tariff share of overall imports) would lower GDP by 0.05%[ix]. This said, estimates vary and there is a high degree of uncertainty in this regard.

Tighter immigration policy and Trump’s proposed mass deportations also threaten to drag on activity via the impact on labour supply and consumer demand. On the plus side, Trump’s proposed tax cuts and deregulation should stimulate growth. However, any resulting economic boost from these measures is more likely to materialize in 2026.

Flagging business confidence in the UK

In contrast to the US, the momentum of the UK economy going into 2025 is weak. Real GDP contracted by 0.1% month-on-month  in October[x]. Business confidence has fallen to post-pandemic lows in the wake of the budget, which raised the rate of employer national insurance (NI) and increased the minimum wage[xi]. Although gains in real wages and falling interest rates should continue to support consumer spending, weak business confidence threatens to impact private sector investment and hiring. Lacklustre productivity growth, in part a product of low levels of business investment, will continue to limit the UK economy’s capacity to grow without generating inflationary pressure.

Although there are clear risks that private sector activity will be crowded out, higher public spending and a loosening in fiscal policy could lead to stronger overall growth in 2025. The Office for Budget Responsibility (OBR) estimates that UK GDP will rise by 2.0% in 2025, following a 1.1% expansion in 2024[xii]. However, this is considerably higher than the consensus, which is penciling in growth of 1.3% this year[xiii].

A key risk for the UK is that concerns over the public finances and inflation will keep borrowing costs high, which could further restrain growth. Another potential headwind comes from the threat of tariffs from the Trump administration (see our commentary of November 2024[xiv]), although this danger is probably greater in the eurozone, which runs a large bi-lateral trade surplus with the US[xv].

Trade vulnerability in the eurozone

Indeed, with manufacturing accounting for a relatively large share of the eurozone economy (particularly in its biggest member, Germany) the region is particularly vulnerable to renewed trade tensions and increased competition from China. Elevated energy prices will continue to put the region at a disadvantage compared with the US. Although falling interest rates should provide support, the drive to consolidate budget deficits means that, unlike in the UK, fiscal policy will act as a headwind[xvi].

Political uncertainty (in France where the new government is struggling to pass its budget, and in Germany, where elections will take place in February) is likely to weigh on sentiment. Although the German election could usher in a more reform-minded, pro-growth government, the eurozone’s largest member will probably continue to flirt with stagnation in 2025. A stronger performance in Spain (which continues to benefit from a booming tourism sector and a weak euro) should help lift growth for the region.

The consensus sees eurozone GDP rising 1.0% in 2025[xvii]. Although tariffs represent a clear downside risk, a possible end to the war in Ukraine could provide a boost to sentiment and eventually a potential stimulus to European firms via reconstruction contracts. Moreover, if US tariffs on Chinese exports prompt Beijing to implement more forceful policy stimulus in 2025, European exporters could benefit from stronger demand.

Inflation divergence?

Government policy could have a large impact on inflation in 2025, and result in divergent trends in the three regions. Inflation fell back in 2024, but in the US and UK it has been somewhat sticky above central banks’ 2% targets, not least as housing and services inflation have remained elevated, the latter driven by continued strong wage growth.

In the US, expectations for inflation in 2025 have been nudged higher in recent months amid continued strong economic growth and concerns that the policies of the incoming Trump administration could boost consumer prices. The Fed’s preferred measure of inflation – the core Personal Consumption Expenditures (PCE) deflator – stood at 2.8% year-on-year in November[xviii]. And in December, the Fed revised its end-2025 forecast upwards for core PCE inflation from 2.2% to 2.5%[xix], implying that policymakers now see inflation remaining considerably above their 2% target this year.

Fed Chair Jerome Powell has indicated that officials have started to consider how Trump’s promises of higher tariffs, tax cuts and tougher immigration policy will impact the economy. Precisely what tariffs will be imposed and the extent to which they are passed on to consumers remains unknown, but an estimate from Goldman Sachs suggests that a one percentage point increase in the US effective tariff rate raises prices by 0.1%[xx]. Combined with an economy that continues to grow at an above-trend pace, the risks of inflation in 2025 appear tilted to the upside.  

In the eurozone, there is greater confidence that inflation will come in close to the European Central Bank’s (ECB) 2% target in 2025. Modest economic growth should curb corporate pricing power and result in softer wage growth, thereby cooling service sector inflation. The weakness of the Euro could pose an upside risk to inflation in 2025. However, US tariffs on China could see Beijing try to divert goods to Europe at reduced prices, which could bear down on goods inflation. The ECB sees headline inflation, which has already fallen to 2.2% in November[xxi], coming in at 2.1% by the end of 2025[xxii].

Although the UK economy has been weak recently, measures announced in the budget threaten to put upward pressure on inflation through 2025. Survey data suggest that many businesses will respond to the hike in employers’ NI contribution and the 6.7% increase in the minimum wage by raising prices[xxiii]. Given lacklustre productivity growth, the continued strength of wage increases (currently running at an annual rate above 5%[xxiv]) is expected to keep services inflation elevated. Headline inflation stood at 2.6% in November[xxv], and the Bank of England’s (BoE) central projection sees a rise to 2.7% by the fourth quarter of 2025[xxvi]. The consensus sees it a little lower, at 2.5%[xxvii].

Falling interest rates

As inflation has fallen back from its post-pandemic highs, the Fed, the ECB, and the BoE were able to start cutting interest rates in 2024. The general expectation is that all three central banks will continue to lower rates in 2025 to avoid real (i.e. inflation-adjusted) interest rates becoming too restrictive and causing unnecessary damage to the economy. However, the scope for rate cuts currently appears greater in the eurozone than in the UK and the US, where inflation has been more stubborn and government policy poses upside risks to price stability.

Having cut its key deposit rate by 25 basis points to 3.0% in December[xxviii], the expectation amongst analysts is that the ECB will cut rates a further 100 basis points to 2.0% by the end of the year[xxix]. In contrast, robust economic data has seen expectations for rate cuts in the US scaled back in recent weeks. Although the Fed also cut its key policy rate by 25 basis points in December (to a range of 4.25-4.50%[xxx]), the median projection of policymakers now anticipates only a further 50 basis points of cuts (to 3.75-4.0%) this year, compared with a 100 basis points of easing expected previously[xxxi]. Futures markets currently price in a Fed Funds rate of close to 4% by end-2025[xxxii].

The BoE will arguably face the trickiest dilemma when it comes to setting interest rates in 2025. A flatlining economy and plunging business confidence during the second half of 2024 suggests the need for aggressive rate cuts. However, upside risks to inflation from the employer NI hike and strong wage growth argue for caution. In December, BoE Governor Andrew Bailey indicated that he expected UK bank rate (currently 4.75%) to fall by 100 basis points to 3.75% by the end of 2025[xxxiii]. Futures markets price in a more moderate easing of around 50 basis points to 4.2%[xxxiv].

Risks to consensus

Given the question marks over which policy proposals of the incoming Trump administration will be implemented during the coming months, investors and central bankers face a particularly uncertain outlook in 2025. As usual, developments in the US and the actions of the Fed will set the tone for global financial markets. The current consensus, which anticipates a benign combination of falling interest rates and an economy that continues to grow at an above-trend pace should, if realised, provide a favourable macro backdrop for investors. Rate cuts should lead to a fall in bond yields (at least at the short end of the curve) and lower borrowing costs, while an expanding economy should be supportive of corporate profits.

The downside risks are probably greater in Europe. The risk of a recession in the UK and the eurozone is non-negligible given weak momentum and the potential for increased trade tensions. Steep tariffs and mass deportations of illegal immigrants could trigger a downturn in the US, but in the absence of such policies, the risk of an American recession appear low. The greater concern is that US inflation will continue to run hot, prompting the Fed to delay cuts in interest rates or even hike them. Such a scenario would be challenging for bond and equity markets alike.

In all likelihood, 2025 will be another year when the finely-crafted projections of the forecasting community prove to be wrong. For investors, it is the extent of the forecast error that will matter.