Our investment and economic outlook, January 2025

“Just as supply-side factors such as increased productivity and plentiful labor drove robust growth amid continued disinflation in 2024, we would expect the next-most-likely scenarios to be supply-driven,” said Qian Wang, head of the Vanguard Capital Markets Model® (VCMM).

• Supply-side headwinds. A smaller labor force or reduced productivity could weigh on economic growth and usher in higher prices. Our baseline forecasts account for a degree of such headwinds developing.

• Soft landing. Inflation could return to trend while growth strengthens amid a productivity-induced “soft landing.” The Fed would have more leeway to cut the upper end of its target range to below 4%—but not too much, given our assessment that the neutral policy rate is around 3.5%. (The neutral rate is a theoretical interest rate that would neither stimulate nor inhibit demand in an economy at full employment.)

Less likely, Wang said, are demand-driven scenarios of recession and overheating.

• Recession: A hefty drop-off in demand could slow both growth and inflation significantly, forcing aggressive Fed rate cuts.

• Overheating: Expansionary fiscal policy could lift both growth and inflation, forcing the Fed to consider new rate hikes.

We have updated our forecasts for the performance of major asset classes, based on the November 8, 2024, running of the Vanguard Capital Markets Model®. Detailed projections, including annualized return and volatility estimates covering both 10- and 30-year horizons, are available in interactive charts and tables.

The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of January 23, 2025.

Growth momentum should remain solid in the near term, supported by productivity gains and less restrictive monetary policy. Actions taken in the first days of the new U.S. administration don’t immediately change our economic outlook.

• Monetary policy: In December, the Fed cut short-term rates by 25 basis points to a range of 4.25%–4.5% and signaled only two more cuts in 2025. That would bring the year-end 2025 target to a range of 3.75%–4%, largely in line with our forecast.

• GDP: The economy grew at an annual rate of 3.1% in the third quarter. We foresee 2025 GDP growth remaining above 2%, a view that accounts for potential changes to trade and immigration policy. Additional 10% tariffs on China, if implemented, would fall within that baseline view. However, the initiation of 25% tariffs on Canada and Mexico would represent a downside risk to U.S. growth and an upside risk to U.S. inflation.

• Inflation: We foresee the core Personal Consumption Expenditures Price Index, the Fed’s preferred inflation gauge which excludes volatile food and energy prices, falling to 2.5% by the end of 2025.

• Labor market: The unemployment rate, which fell to 4.1% in December, could rise marginally in 2025 to around the mid-4% range.
  
  

A weak growth outlook and benign inflation should translate into a relatively dovish European Central Bank (ECB) stance in 2025. However, two near-term risks to the inflation outlook—the prospect of rising natural-gas prices and a weakening euro—represent monetary policy risks as well.

• Monetary policy: The ECB cut its deposit facility rate again in December, and we expect it will continue cutting by 25 basis points until the July meeting and then hold it at 1.75%.

• GDP: We continue to forecast below-trend growth around 0.5% in 2025. The prospect of additional tariffs and related uncertainty would likely weigh on consumer and business sentiment. Continued malaise in the manufacturing sector is likely to dampen final demand.

• Inflation: The pace of inflation increased for a third consecutive month in December, rising to 2.4% year over year, its fastest rate of increase since July 2024. However, amid weak growth, we expect both headline and core inflation to end 2025 below 2%.

• Labor market: With an economic slowdown in Germany and broader growth pressures, we foresee the unemployment rate rising toward 7% by the end of 2025.
   

A recent rise in gilt yields as part of a global sell-off, if sustained, is likely to tighten financial conditions, increasing downside risks to our economic growth forecast.

• Monetary policy: Recent events, taken together, are dovish for the monetary policy outlook. Tighter financial conditions are likely to weigh on economic growth, and the labor market is softening. That said, sustained weakness in the pound could heighten inflation risks and challenge the monetary policy view. We expect quarterly rate cuts in 2025 that would leave the bank rate at a below-consensus 3.75% at year-end.

• GDP: We continue to expect 2025 GDP growth of around 1.4%, but risks skew to the downside given tightening financial conditions and early signs of cracks in the labor market.

• Inflation: We foresee subdued progress, with core inflation falling to a 2.4% pace by the end of 2025. Risks skew to the upside given the prospect of global trade tensions and the potential for employers to pass increased national insurance contributions on to the consumer.

• Labor market: Small cracks may be appearing in the labor market as elevated wage growth makes it more expensive for companies to hire. The unemployment rate rose to 4.4% from September through November 2024 and we foresee it ending 2025 around its current level. 
   

Despite its having paused in December, we expect the Bank of Japan (BoJ) to resume its rate-hiking cycle in 2025 amid a virtuous cycle of wage and price increases.

• Monetary policy: Should the economy and inflation progress in line with our outlook, we continue to expect the BoJ to raise its policy rate target to 1% by the end of 2025. The timing and scale of hikes will depend on the outcome of nationwide union wage negotiations, potential U.S. tariffs, market volatility, and domestic politics.

• GDP: We foresee 2025 growth above trend at around 1.2%, driven by a pickup in domestic demand as wage gains outpace inflation. Risks from the global economy may increase uncertainty, with potential U.S. tariffs offsetting China’s policy stimulus, though the overall impact for Japan is likely to be limited.

• Inflation: The pace of inflation increased in November to 2.9% year over year. Steady wage growth on the back of strong corporate profits and structural labor shortages will likely support a recovery in domestic consumption and keep core inflation robust around 2% in 2025.

• Labor market: Japan’s unemployment rate held steady at 2.5% in November. Japan is facing a structural labor shortage, which is likely to exert continued upward pressure on wages.
   

A strong end to the year helped China achieve its 2024 economic growth target. The headwinds could be stronger in 2025, with a spotlight on the degree of policy support offered and potential U.S. tariffs.

• Monetary policy: We foresee the policy seven-day reverse repo rate being cut to 1.2% in 2025 and further reductions to banks’ reserve requirement ratios to facilitate fiscal expansion. Although we expect the People’s Bank of China to allow for some currency depreciation in 2025 in anticipation of higher tariffs, concerns on that front could constrain the magnitude of policy rate cuts.

• GDP: We continue to expect real GDP growth to slow to around 4.5% in 2025 as the drag from anticipated tariffs will likely outweigh the benefits of policy easing.

• Inflation: For 2025, we foresee core inflation of around 1.5%, with only a modest inflationary thrust from currency depreciation in the face of higher tariffs.

• Labor market: The unemployment rate increased to 5.1% in December from 5% in November. We anticipate it will remain around current levels in 2025.
   

Restrictive monetary policy has weighed on demand while stagnant productivity continues to hold the economy back. This suggests that a sustained period of below-potential demand will be required to return inflation to the midpoint of the 2%–3% target set by the Reserve Bank of Australia (RBA).

• Monetary policy: The RBA noted that it was “gaining some confidence that inflation is moving sustainably toward target.” However, we expect the central bank to remain patient and that a tight labor market will keep it from initiating rate cuts until the second quarter of 2025.

• GDP: The economy is poised to recover gradually in 2025, having likely experienced its slowest growth in 32 years in 2024 amid sticky inflation and elevated interest rates. We foresee full-year 2025 GDP growth of around 2%.

• Inflation: Given low productivity growth and its resulting higher unit labor costs, we don’t foresee core inflation falling sustainably to the midpoint of the RBA’s 2%–3% target range until later this year.

• Labor market: The unemployment rate is expected to rise to around 4.6% in 2025 as financial conditions tighten amid elevated interest rates. 
   

The Bank of Canada (BoC) cut short-term interest rates by 1.75 percentage points in 2024. However, if the U.S. were to implement tariffs of 25% on Canadian goods and Canada then implemented 25% tariffs on U.S. goods, we would expect a significant drop-off in Canada’s growth and a pickup in inflation significant enough that the BoC would need to reverse course and raise interest rates.

• Monetary policy: The strength in the December labor report would have to repeat itself over the next month or two to alter the BoC’s course. We expect the BoC to cut rates to around 2.5% in 2025.

• GDP: Economic growth slowed in the third quarter. We expect GDP growth below 2% in 2025 despite monetary policy that we expect to turn accommodative. Parliamentary elections late this year and interactions with the new U.S. administration will be worth watching.

• Inflation: Core inflation, which was 2.1% year over year in December, could land in the range of 2.1%–2.4% in 2025.

• Labor market: The unemployment rate fell to 6.7% in December and we anticipate it will hover in the high-6% range in 2025 as the economy grows below its potential.
   

We expect the monetary policy easing cycle to broaden, albeit with rates remaining in restrictive territory as a strong U.S. dollar threatens to stoke emerging markets inflation. Trade developments are likely to be in focus throughout 2025.

• Inflation: It has generally remained near or below target in emerging Asia. It is nearing target amid slowing growth in emerging Europe, though rising energy prices present a risk. Inflationary pressures persist in Latin America, however, with services inflation expected to remain elevated, keeping broad inflation gauges above central banks’ targets in 2025.

• Brazil: The central bank raised its policy Selic rate to 12.25% in December , the third straight increase in as many policy meetings. Policymakers noted that “headline inflation and measures of underlying inflation are above the inflation target and have increased in recent releases.”

• Mexico: The economy surged in the third quarter, but restrictive interest rates and U.S.-related policy uncertainty make us bearish on Mexico, where we expect growth in a range of 1.25%–1.75% in 2025. The central bank cut its overnight interbank rate target to 10% in December, and we expect it to continue falling with the rate target ending 2025 in a range of 8%–8.25%. We anticipate core inflation will fall to 3.25%–3.5% in 2025.

• Chile: The central bank lowered its policy rate to 5% in December, amid pessimistic consumer and business expectations.

• Think differently about global diversification (article, issued January 2025)
• Look at the bigger equity picture: AI beyond tech (article, issued January 2025)
• Navigating 2025: Some key insights from the past year (article, issued December 2024)
• Germany’s economic woes go beyond the energy crisis (article, issued December 2024)