Key points

• In the US, interest rates remained unchanged within a range of 4.25%–4.5%.

• In the euro area, we expect further interest rate cuts due to a weak economic growth outlook and benign inflation.

• In the UK, there are signs of stagflation emerging, with low economic growth and rising inflation.

• Investor sentiment in China is improving, bolstered by the emergence of AI start-up DeepSeek. 

US Federal Reserve (Fed) policymakers left their target for short-term interest rates unchanged, in a range of 4.25%–4.5%, in their first meeting of 2025. We expect they will continue to bide their time before introducing further rate cuts.

The euro area’s weak growth outlook and benign inflation is likely to encourage the European Central Bank (ECB) to be relatively dovish in 2025. Following Germany’s recent election and with the potential for peace negotiations over Ukraine, uncertainty is high.

In the UK, recent economic conditions have shown signs of stagflation, with the economy experiencing minimal growth and rising inflation.

Investor sentiment in China is improving, bolstered by the emergence of AI start-up DeepSeek and a significant rise in the Shanghai Composite Index from a September 2024 low. 

United States

GDP: We expect economic growth to remain above 2%, reflecting assumed changes in trade and immigration policies.

Monetary policy: We expect the Fed to cut interest rates twice in the second half of the year - a deferral from our previous forecast of rate cuts in the first half, reflecting the recent strength in employment and inflation reports.

Inflation: We believe that inflation will remain in focus. A recent survey¹ indicated that consumers expect 4.3% inflation over the next year, up a full percentage point from January. It isn’t clear whether the readings reflect a signal or noise amid policy uncertainty.

Labour market: In our view, the unemployment rate will rise marginally in 2025, to the mid-4% range. If labour supply constraints exceed our base-case assumptions, however, unemployment may fall and both wage growth and inflation may climb.

Euro area

GDP: We expect the euro area to deliver below-trend growth of around 0.5% in 2025, with continued malaise in the manufacturing sector likely to weigh on final demand. The prospect of additional tariffs and related uncertainty would likely weigh on consumer and business sentiment.

Monetary policy: We expect the ECB to cut its policy rate by 0.25 percentage points at each meeting until the July meeting, and then hold it at 1.75%. The current rate is 2.75%.

Inflation: We anticipate the headline and core rates of inflation to both end 2025 below 2%.

Labour market: The unemployment rate stood at 6.3% in December. We expect it to rise towards 7% by the end of 2025. 

United Kingdom

GDP: We expect UK economic growth of around 0.7% in 2025, down from our previous forecast of 1.4%. This reflects, in part, a deterioration in forward-looking data, particularly on the labour market.

Monetary policy: We expect quarterly interest rate cuts by the Bank of England that would leave the bank rate at 3.75% at year-end, down from 4.5% today.

Inflation: In our view, headline inflation will end 2025 at 2.5% and core inflation, which excludes volatile food, energy, alcohol and tobacco prices, to end the year at 2.7%, both on a year-on-year basis. Both forecasts are 0.3 percentage points higher than our previous estimates.

Labour market: We expect the unemployment rate to rise to 4.7% by year-end, up from 4.4% in the October-to-December 2024 period.

Japan

Monetary policy: We continue to expect the Bank of Japan to raise its policy rate target to 1% by the end of 2025, up from 0.5% currently. We believe rate adjustments are intended to align monetary policy with a normalised inflation regime, not as a bid to curtail demand in response to rising inflation.

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.

Inflation: We believe that core inflation will remain robust at about 2% in 2025.

Labour market: The country is facing a structural labour shortage, which is likely to continue exerting upward pressure on wages.

China

GDP: We anticipate near-term momentum in economic growth as policy support takes effect. Real (inflation-adjusted) growth is likely to slow to about 4.5% this year due to trade tariffs.

Monetary policy: We expect increased fiscal stimulus, including a one-off overshoot of the debt ceiling to address local government debt and excess housing supply. Monetary easing will support fiscal expansion.

Inflation: Core inflation is expected to be about 1.5% this year, thanks mainly to currency depreciation in the face of higher tariffs. Otherwise, deflationary pressures remain. Producer prices were down 2.3% year-on-year in January, a 28th consecutive month of decline.

Labour market: We expect the unemployment rate to remain unchanged in 2025 (from 5.1% in December 2024). Structural mismatches in labour supply and demand, especially among younger workers, may persist. 

Emerging markets

We expect the monetary policy easing cycle to broaden, albeit with rates remaining in restrictive territory as a strong US dollar threatens to stoke emerging market 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 follows².

¹ A survey from the University of Michigan.

² 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

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Past performance is not a reliable indicator of future results. The performance data does not take account of the commissions and costs incurred in the issue and redemption of shares.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Important information

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The information contained in this document is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this document does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.

The information contained in this document is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

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