Our investment and economic outlook, February 2025

If productivity were to fall back to post-global-financial-crisis averages, Adam Schickling, a Vanguard senior economist, said wage growth would have to come down closer to 3% to remain noninflationary.

Productivity is notoriously difficult to predict. Restrictions in labor supply and trade could impede it. However, productivity is driven most by the application of technology to work. Vanguard’s global chief economist, Joe Davis, is cautiously optimistic about the potential for artifical intelligence to boost productivity growth and improve living standards, offsetting the headwind of an aging population.

We have updated our forecasts for the performance of major asset classes, based on the December 31, 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 February 20, 2025.

Federal Reserve 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.

We further expect:

• The Federal Reserve to cut 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 labor and inflation reports.

• 2025 economic growth of 2.1%, reflecting assumed changes in trade and immigration policies.

• The unemployment rate to rise marginally in 2025, to the mid-4% range. If labor supply constraints exceed our base-case assumptions, however, unemployment may fall and both wage growth and inflation may climb.

• Inflation to remain in focus. A University of Michigan survey this month 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. 
  
  

Recent economic conditions in Canada have been mixed. Growth has slowed and inflation has moderated, despite strength in the labor market.

We expect:

• Economic growth of less than 2% in 2025, despite more accommodative monetary policy. Parliamentary elections late this year and interactions with the new U.S. administration bear watching.

• The core rate of inflation to register 2.1%–2.4% this year, just above the midpoint of the Bank of Canada’s 1%–3% target.

• The unemployment rate to remain this year around current levels—it stood at 6.6% in January—with much depending on trade uncertainty and immigration developments.

• The Bank of Canada to cut its target for short-term interest rates at a more cautious pace this year, given the tariff uncertainty and its negative impact on growth and upside risk to inflation.
   

A weak growth outlook and benign inflation likely will encourage the European Central Bank (ECB) to be relatively dovish in 2025. With Germany’s elections taking place February 23 and the potential for peace negotiations over Ukraine, uncertainty is high.

We expect:

• The ECB to cut its policy rate by 0.25 percentage point at each meeting until the July meeting, and then hold it at 1.75%. The current rate is 2.75%.

• Below-trend economic growth around 0.5% for 2025, with continued malaise in the manufacturing sector likely to weigh on final demand.

• The headline and core rates of inflation to both end 2025 below 2%.

• The unemployment rate to rise toward 7% by the end of 2025. It stood at 6.3% in December. 
  
  

Recent economic conditions in the United Kingdom have shown signs of stagflation, with the economy experiencing minimal growth and rising inflation.

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.

• 2025 economic growth of 0.7%, down from our previous forecast of 1.4%, reflecting in part a deterioration in forward-looking data, particularly on the labor market.

• Headline inflation to 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-over-year basis. Both forecasts are 0.3 percentage point higher than our previous estimates.

• The unemployment rate to rise to 4.7% by year-end, up from 4.4% in the October-through-December 2024 period.
   

The Bank of Japan resumed its rate-hiking cycle in January. A stronger-than-expected GDP reading amid continued demand for exports supports our view for further interest rate hikes.

We expect:

• The Bank of Japan to gradually increase its policy rate to 1% by year-end, up from 0.5% today. We believe rate adjustments are intended to align monetary policy with a normalized inflation regime, not as a bid to curtail demand in response to rising inflation.

• 2025 economic growth to be above trend at about 1.2%, driven by a pickup in domestic demand as wage gains outpace inflation.

• Core inflation to remain robust at about 2% in 2025.

• A structural supply shortage in the labor market to continue exerting upward pressure on wages.
   

Investor sentiment in China is improving, bolstered by the emergence of AI start-up DeepSeek and a 24% rise in the Shanghai Composite Index from a September 2024 low. President Xi Jinping's meeting with prominent entrepreneurs on February 17 underscores the growing importance of the private sector.

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.

• Near-term momentum in economic growth, as policy support takes effect. Real (inflation-adjusted) growth likely will slow to about 4.5% this year due to trade tariffs.

• The rate of core inflation 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 over year in January, a 28th consecutive month of decline.

• The unemployment rate to remain this year around its current (5.1% in December) level. Structural mismatches in labor supply and demand, especially among younger workers, may persist. 
  
  

On February 18, the Reserve Bank of Australia (RBA) cut interest rates for the first time in more than four years, reducing its policy cash rate target by 0.25 percentage point to 4.1%. Despite this move, the RBA is expected to proceed cautiously with further cuts due to sticky services inflation and a tight labor market.

We expect:

• The central bank to trim its cash rate target to 3.5% by year-end.

• Economic growth of about 2% for full-year 2025, with support from rising real (inflation-adjusted) household incomes, a rebounding housing market, and rate-cut expectations.

• The annual pace of trimmed mean inflation, which excludes items at the extremes, to fall to the midpoint of the RBA’s 2%–3% target range late this year. It registered 3.2% in the fourth quarter of 2024.

• The unemployment rate to rise to about 4.6% this year, up from 4.1% in January, as financial conditions tighten.
  
  

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.

In Mexico, we expect:

• A central bank easing cycle that began in March 2024, when the policy rate was 11.25%, to continue. We forecast that the overnight interbank rate will end 2025 in a range of 8%–8.25%, down from 9.5% today.

• The core rate of inflation, which excludes volatile food and energy prices, to fall to 3.25%–3.5% in 2025, above the midpoint of Banxico’s 2%–4% target range.

• Economic growth of 1.25%–1.75% this year, with potential for further slowing if trade tensions escalate.

• Our economic and markets hub
• After decades of stagnant growth, Japan is back (article, issued October 2024)  
• Think differently about global diversification (article, issued January 2025)
• Look at the bigger equity picture: AI beyond tech (article, issued January 2025)
• Germany’s economic woes go beyond the energy crisis (article, issued December 2024)