Key Takeaways
- There is reasonable consensus around the 2025 outlook – stagflation in the UK, stagnation in Europe and Goldilocks in the US.
- In the UK, inflation and unemployment are set to tick upwards. The Bank of England will have to balance keeping inflation under control with the backdrop of a weak economy.
- The US economy looks set to perform well with modest cuts to interest rates (we think there may be more than expected). A new President adds some uncertainty to the picture.
- Despite structural problems in manufacturing, we could see better growth in Europe than many expect.
There is a reasonable consensus about the outlook for 2025. Stagflation in the UK, stagnation in Europe and goldilocks in the US. This week, we’ll look at what this means and ask where consensus might be wrong. After all it’s often economic surprises rather than the outturns themselves that matter for financial markets.
Let’s start with the UK. Regular viewers will know I’ve turned 180 degrees from optimism to pessimism since the election. It’s not all the new government’s fault. The eurozone economy, far and away our biggest trading partner, has been weak. Energy prices were headed lower but are now going up. And it’s not oil that matters here but natural gas. This time last year we were expecting household energy bills to fall this winter, but they’ve actually gone up by 10%. We were also expecting prices to continue to fall in 2025, the best guess now is that they will edge higher. This has hit consumer confidence. But the new government has made matters worse with big increases in taxes, spending and borrowing plus hiking public sector pay and the minimum wage. Now don’t get me wrong, increasing minimum wages are to be welcomed from a social perspective – and the policy has worked well until recently. But the scale of the change now looks set to damage the economy. After near 10% rises in the last two years, the minimum wage is going up by 6.7% in April. That will take the cumulative increase to 37% since 2021. For some younger workers it is more like 50%. The massive increase in employers’ national insurance contributions also due in April has made all this much, much worse. Without productivity gains – notably absent in the UK of late– this will lead to lower employment, higher inflation and companies going out of business. Labour intensive companies and those in depressed regions will be hardest hit. It’s not all bad. UK consumers have high savings and can spend more. Those on the minimum wage will spend every extra pound they get. The new Chancellor has retained the generous investment incentives introduced by the previous government and we should see a boost to productivity. Construction activity in commercial and civil engineering is very strong (though the opposite is true for house building) according to my favourite purchasing managers’ survey and promises by the new government to unblock planning restrictions are helping here. But I reckon the UK economy will see higher inflation and weaker growth in 2025. This will create a dilemma for the Bank of England – they’ll need to maintain high interest rates to keep a lid on inflation but will come under pressure to continue cutting given the weakness of the economy. The governor Andrew Bailey has suggested we might get a full 1% off the bank rate this year. My guess is that we’ll see fewer cuts.
The US economy is of course the most important, in many ways more important for UK financial markets than the UK itself. And I agree with consensus that the US will continue to perform well. Goldilocks continues with growth not hot enough to stop interest rates falling nor cold enough to risk recession. Whereas we face big tax increases, the US is seeing the opposite, with much of the tax credits and subsidies under the IRA and CHIPS Acts yet to be spent. Consumer confidence is strong. Yes, inflation looks set to remain above target in 2025 but only marginally so and the market is only expecting modest interest rate cuts – they might be pleasantly surprised. The President-elect’s policies are the big uncertainty of course but the focus on supply-side measures is to be welcomed and tariffs may well do more damage to her trading partners than the US itself.
As for Europe, the market consensus is so gloomy that I reckon we’ll see better growth. Consumer spending there has been weak and there are serious structural problems in manufacturing, notably in Germany. But consumer finances are healthy, confidence is improving, and interest rates are low and falling. So, I reckon Europe will do just a little better than expected this year.
My final forecast is more of a hope and relates to the terrible conflicts in Ukraine, the Middle East and much of Africa which have caused misery for millions of people. Some of these conflicts should end or at any rate diminish in 2025. If I get just one forecast right in 2025, let it be this one.
