Key points
- In the US, healthy economic growth but potential tariffs could derail the trajectory of interest rates and inflation.
- Euro area growth is moribund, with growth challenges only broadening, particularly in Germany.
- UK growth looking increasingly challenged.
- Consumer activity in Japan is seeing a revival.
- China needs a stimulus.
US economic growth should remain solid in the near term, supported by productivity gains and a less restrictive monetary policy. Actions taken in the first days of the new US administration don’t immediately change our economic outlook.
The euro area’s weak growth outlook and benign inflation should translate into a dovish European Central Bank (ECB) stance in 2025. However, the prospect of rising natural-gas prices and a weakening euro could put this at risk.
In the UK, we expect trend growth in 2025, but downside risks to achieving this have increased.
While China’s strong end to 2024 helped it hit its economic growth target, stronger headwinds in 2025 from potential US tariffs intensify the spotlight on the degree of policy support.
United States
GDP: We expect economic growth to remain above 2%, which includes the effect of potential changes to trade and immigration policies, such as additional 10% tariffs on imports from China. However, the proposed 25% tariffs on Canada and Mexico imports are risks to US growth and inflation.
Monetary policy: In December, the Federal Reserve (Fed) cut short-term rates by 25 basis points (bps)1 to a range of 4.25%–4.5% and signalled only two more cuts in 2025. That would bring the year-end 2025 target range to 3.75%–4%, which is in line with our forecast.
Inflation: We expect the core Personal Consumption Expenditures (PCE) Price Index, the Fed’s preferred inflation gauge that excludes volatile food and energy prices, to fall to 2.5% by the end of 2025.
Labour market: While December’s unemployment rate fell to 4.1%, we believe it is likely to rise marginally to around the mid-4% during 2025.
Euro area
GDP: We expect the euro area will deliver below-trend growth of around 0.5% in 2025. The prospect of additional US tariffs is likely to weigh on consumer and business sentiment. The continued malaise in the manufacturing sector is likely to dampen final demand.
Monetary policy: The ECB cut its deposit facility rate in December, and we expect the central bank to continue cutting rates in 2025 by 25 basis points at each of its meetings up to July. Thereafter we expect the central bank will hold interest rates at 1.75%.
Inflation: Prices increased for a third consecutive month in December, rising to 2.4% over the previous 12 months. This was its fastest rate of increase since July 2024. Nevertheless, amid weak growth, we expect both headline and core inflation to end 2025 below 2%.
Labour market: With an economic slowdown in Germany, we see the euro area jobs market weakening. The unemployment rate is likely to rise towards 7% by the end of 2025.
United Kingdom
GDP: We continue to expect the UK’s economy to grow at around 1.4% in 2025. However, risks are skewed towards more modest growth, especially if financial conditions remain tight and early signs of weakness in the labour market worsen.
Monetary policy: Recent events, such as higher gilt yields and increased company costs, are dovish for the interest-rate outlook. We expect quarterly rate cuts in 2025 that would leave the Bank rate at a below-consensus 3.75% at year-end.
Inflation: We foresee subdued progress in inflation, with core inflation falling to a 2.4% by the end of 2025. Risks to this are to the upside due to possible global trade tensions and the potential for employers to pass on their increased national insurance contributions to consumers. Additionally, a prolonged period of sterling weakness could heighten inflation risks and challenge the dovish monetary policy view.
Labour market: Small cracks may be appearing in the labour market, as the current level of wage growth and other costs make it more expensive for companies to hire new workers. The unemployment rate rose to 4.4% from September to November 2024 and we foresee it ending 2025 around its current level.
Japan
Monetary policy: We continue to expect the Bank of Japan to raise its policy rate target to 1% by the end of 2025. The timing and scale of the rate hikes will depend on the outcome of nationwide union wage negotiations, potential US tariffs, market volatility and domestic politics.
GDP: We expect 2025 growth to be above trend at around 1.2%, driven by an increase in domestic demand, as wage increases outpace inflation. However, risks from the global economy could weigh on Japan’s progress, particularly if potential US tariffs offset China’s policy stimulus. Despite this, the overall impact for Japan is likely to be limited.
Inflation: Over the 12 months to November inflation increased to 2.9%. Steady wage growth, driven by strong corporate profits and structural labour shortages, is likely to support a recovery in domestic consumption and keep core inflation robust at around 2% in 2025.
Labour market: Japan’s unemployment rate remained steady at 2.5% in November. The country is facing a structural labour shortage, which is likely to continue exerting upward pressure on wages.
China
GDP: China achieved its 2024 economic growth target after a strong end to the year. However, the country is facing stronger headwinds in 2025. These include uncertainty about the degree of government policy support and the level of potential US tariffs. We expect the country’s economic growth to slow down to around 4.5% in 2025, as the drag from tariffs outweigh the benefits of lower interest rates.
Monetary policy: We foresee the People’s Bank of China’s (PBOC) policy seven-day reverse repo rate being cut to 1.2% in 2025, with further reductions to the reserve requirement ratio for China’s banks to facilitate fiscal expansion. Although we expect PBOC to tolerate some currency depreciation in 2025 in anticipation of higher tariffs, this could potentially limit the scope of policy rate cuts.
Inflation: Core inflation is expected to be subdued over 2025 at 1.5%, despite currency depreciation in the face of higher tariffs.
Labour market: The unemployment rate is expected to remain unchanged in 2025 after December’s slight increase to 5.1% from 5% in November.
Emerging markets
We expect the interest-rate-cutting cycle to broaden, albeit with rates remaining in restrictive territory, as a strong US dollar threatens to stoke emerging markets inflation. Trade developments are likely to be in focus throughout 2025.
Asset-class return outlook
Vanguard has updated its 10-year annualised outlooks for broad asset class returns through the most recent running of the Vanguard Capital Markets Model® (VCMM), based on data as at 31 December 2024.
Our 10-year annualised nominal return projections, expressed for local investors in local currencies, are as follows1.
1 The figures are based on a 2-point range around the 50th percentile of the distribution of return outcomes for equities and a 1-point range around the 50th percentile for fixed income. Numbers in parentheses reflect median volatility.
IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model® regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time. The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include US and international equity markets, several maturities of the US Treasury and corporate fixed income markets, international fixed income markets, US money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
The primary value of the VCMM is in its application to analysing potential client portfolios. VCMM asset-class forecasts—comprising distributions of expected returns, volatilities, and correlations—are key to the evaluation of potential downside risks, various risk–return trade-offs, and the diversification benefits of various asset classes. Although central tendencies are generated in any return distribution, Vanguard stresses that focusing on the full range of potential outcomes for the assets considered, such as the data presented in this paper, is the most effective way to use VCMM output.
The VCMM seeks to represent the uncertainty in the forecast by generating a wide range of potential outcomes. It is important to recognise that the VCMM does not impose “normality” on the return distributions, but rather is influenced by the so-called fat tails and skewness in the empirical distribution of modeled asset-class returns. Within the range of outcomes, individual experiences can be quite different, underscoring the varied nature of potential future paths. Indeed, this is a key reason why we approach asset-return outlooks in a distributional framework.
Investment risk information
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Important information
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