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The global outlook remains uncertain as major economies work through a host of cyclical, structural, and policy challenges. By and large, however, we expect major economies to muddle through with continued growth.
Prospects vary across regions, and risks are tilted to the downside near term in export-oriented economies – partly linked to trade tensions.
Policymakers' decisions in the US, Europe, and China can make a decisive positive impact on economic outcomes. Inflation is likely to stay above 2% in the US and Europe, posing challenges for central banks.
Narrowing growth gaps and further cautious rate cuts – We foresee healthy but moderating US growth while momentum improves in Europe. We expect the UK to outperform a Eurozone held back by structural challenges in Germany and France. While China is likely to continue to slow on trend, Japan looks set for a cyclical rebound. We expect further rate cuts by major central banks in 2025: 100bp from the European Central Bank (ECB), 75bp from the Bank of England (BoE), and 50bp from the US Federal Reserve (Fed).
A host of challenges – The global economy faces significant risks from trade wars, geopolitical tensions, and financial instability linked to excessive borrowing by governments in key major economies. The US could see inflation reignite due to President Donald Trump's tariffs and tax cuts, while Europe grapples with energy security and other supply-side issues. China's growth may be hampered by chronic demand weakness and trade tensions. Policymakers must navigate these risks carefully to avoid another period of low growth and elevated inflation.
All eyes on policymakers – Policy choices are likely to have a major impact on economic trends in 2025-26, in our view. In the US, we turn our attention to the economic plans of the new Trump administration and the reaction of the Fed. In Europe, we focus on the response of the UK economy to fiscal and monetary loosening, the impact of German elections, French budget negotiations, and whether the ECB will turn suitably aggressive if growth risks escalate. In China, policymakers need to stay the course with further efforts to stimulate domestic demand. In their typical haphazard fashion, we expect policymakers to mostly get it right. As a result, we remain cautiously positive in our outlook.
Figure 1: Peel Hunt real GDP projections versus Bloomberg consensus
% YoY. Annual data. Source: Peel Hunt estimates (PH), Bloomberg consensus (BB) taken on 3 January 2025.
Overview: will policymakers get it right?
Even though the major shocks that disturbed the global economy since 2020 – the COVID-19 pandemic and Russian-gas disruptions – are mostly in the rearview mirror, the economic outlook for major economies is still highly uncertain. A wide range of outcomes over the medium-term remains possible.
While many forces will shape economic trends in 2025 and 2026, the overriding factor – in our view – will be whether policymakers make the right decisions in the three key regions that matter most for the global economy.
For now, we have more questions than answers.
In the US:
1) Will Trump’s economic plans, which include pro-growth tax cuts and deregulation as well as anti-growth import tariffs and immigration curbs, lead to more growth and less inflation or less growth and more inflation?
2) How will the Fed manage the growth-inflation trade-off as the new administration undertakes its policy experiment, and will it yield to potential political pressure from Trump to aggressively lower rates?
In Europe:
1) Will the BoE’s gradual easing cycle and the Labour government’s planned investment-oriented fiscal expansion be enough to help the UK economy gain sufficient momentum to escape its recent growth slump?
2) Will German elections result in a genuine change in the policy direction – possibly including a change in the constitutional debt brake - to promote domestic demand growth and fix longer-run supply challenges?
3) Will the French parliament strike a deal that puts fiscal policy on a sustainable path in a way that does not involve an aggressive rolling back of Macron’s past pro-growth supply side reforms?
4) Will the European Central Bank (ECB) abandon its cautious approach to easing monetary policy and turn suitably aggressive with significant rate cuts if momentum softens further in early 2025?
In Asia:
1) Will targeted fiscal and credit measures in China be enough to promote a healthy expansion in consumer spending and stabilise growth momentum? And, if not, will policymakers turn ever more aggressive to prevent China from fully falling into a Japan-style liquidity trap?
2) Will policymakers at the Bank of Japan (BoJ) manage to further normalise interest rates without undermining progress towards a more normal inflation environment and in a way that does not hamper economic performance or trigger financial market volatility?
Beyond these region-specific questions, global performance will be shaped by how countries succeed or fail to cooperate on three other critical issues: 1) the Russia-Ukraine conflict; 2) troubles in the Middle East, including but not limited to the Israel-Palestine conflict; and 3) the rules governing global trade.
If policymakers can get the big decisions right, global economic growth can improve and become more synchronised while inflation remains low. As stability begets confidence, a feel-good factor could emerge. However, if policymakers get it wrong – especially if geopolitical tensions escalate or major economies become embroiled in major tit-for-tat tariff wars, the global economy could face another period of low growth at elevated inflation. We could not rule out recessions in major economies.
Judging by experience, when the two-sided risks seem unusually large, the outcome tends to fall somewhere in the middle – which is where our base case lies. Economies and markets have a way of adjusting and muddling through.
Real GDP outlook – Growth gaps can narrow somewhat
As our base case, we anticipate a broadening economic expansion across major economies over the next two years: with continued but moderating growth in the US and China as well as cyclical expansions in the UK, Eurozone, and Japan (Figure 2). Bloomberg consensus in brackets.
- For the UK, we forecast YoY real GDP growth of 1.4% (1.4%) in 2025 and 1.8% (1.5%) in 2026.
- In the Eurozone, we project real GDP growth of 1.1% (1.0%) in 2025 followed by 1.4% (1.2%) in 2026, with Germany at 0.5% (0.4%) and 1.2% (1.0%) and France at 0.8% (0.7%) and 1.1% (1.2%), respectively.
- In the US, we expect growth in real GDP of 2.0% (2.1%) and 2.0% (2.0%) in 2025 and 2026, respectively.
- We look for real GDP growth in China of 4.5% (4.5%) in 2025 and 4.3% (4.2%) in 2026.
- In Japan, we project a real GDP gain of 1.2% (1.2%) in 2025 followed by a rise of 0.9% (0.9%) in 2026.
Risk assessment: the recent weakening of economic data – especially in trade and production – across major economies tilts the risks to these calls to the downside near-term. Further out, the risks are balanced. See page 5 for our detailed risk assessment.
Figure 2: Peel Hunt projections for real GDP
% YoY. Peel Hunt projections for 2024-26. Annual data. Sources: ONS, BEA, Eurostat, China National Bureau of Statistics, Cabinet Office of Japan
Central banks cautiously ease amid still elevated inflation
After surging in 2022 and 2023, inflationary pressures moderated last year. Measured by the consumer price index, inflation slowed between 2023 and 2024 from 4.1% to 2.9% in the US, from 7.3% to 2.5% in the UK, from 5.4% to 2.3% in the Eurozone, and from 3.3% to 2.6% in Japan, respectively. In China, which remains a special case due to a huge domestic imbalance of excess supply and faltering demand, inflation stabilised at a low 0.3% rate in 2023 and 2024.
Looking to 2025 and 2026, we expect inflation to stay somewhat elevated at slightly above central banks’ 2% targets as long-term structural factors, including trade frictions and labour shortages caused by ageing populations, put upward pressure on prices via higher input costs and wages.
- In the UK, we expect inflation to remain stable at 2.4% in 2025 and 2026.
- In the US, we look for inflation to stay at 2.6% in both 2025 and 2026.
- For the Eurozone, we project 2.2% inflation in both 2025 and 2026.
- In China, we look for inflation to rise from 0.8% in 2025 to 1.6% in 2026.
- In Japan, we expect inflation to moderate from 2.2% in 2025 to 1.8% in 2026.
Stable but sticky inflation will pose a modest problem for central banks as they try to neutralise their still tight monetary policies (Figure 3).
- In the UK, we look for the BoE to lower the bank rate three times at a pace of one 25bp cut per quarter in 1Q, 2Q, and 3Q of 2025. This would reduce the bank rate from 4.75% to 4.00% by end-2025. In 2026, we expect the BoE to keep the bank rate unchanged at 4.0%.
- In the US, we project 50bp more of cuts in 1H25 by the Fed to take the upper limit of the funds rate corridor from 4.5% to 4.0%. In 2026, we expect the fed to keep its policy rate unchanged at 4.0%.
In the Eurozone, we expect the ECB to lower the deposit rate by 100bp in the first half of 2025 from 3.0% to 2.0%. In 2026, we expect the ECB to lift the deposit rate by 50bp to take it to 2.5% by the end of the year.
Figure 3: Peel Hunt projections for central bank policy rates
In %. Shaded area shows projection. Quarterly data. Sources: Federal Reserve, ECB, BoE, Peel Hunt
Assumptions and risks
Our call for sustained economic growth across major economies rests on three key assumptions:
- Inflation remains sufficiently under control (i.e., below 3% in the US and 2.5% in Europe) for central banks to normalise monetary policy further. In the US and the UK, we expect central banks to remove almost all of their policy restrictiveness, by taking rates to close to neutral in 2025. In the Eurozone, we expect the ECB to turn sufficiently concerned about growth risks to take policy to an actively easy setting in 2025.
- Economies mostly adjust to trade frictions. While trade wars will be disruptive, exchange rate adjustments and supply-chain shifts will allow economies to partly adapt to tariff shocks. Our base case is that major economies will strike early deals to avoid US blanket tariffs. Regarding US policy towards China, for instance, there is a big difference between the threatened 60% tariff on all Chinese goods and large but concentrated tariffs that fall only on specific goods - say EVs.
- No serious protracted bouts of financial instability. We need to closely monitor the small but serious risk that misguided fiscal policies in the US and France could amplify inflation and debt sustainability concerns, triggering a major bond market rout. A tantrum in the US Treasuries market could badly destabilise global financial markets.
Two-sided macro risks
Beyond the serious tail risks (see final section below) that are always somewhat present in one form or another, if we abstract from these potential fault lines, we see that core macro risks are roughly balanced.
- On the upside: the diffusion of artificial intelligence (AI) technologies promises to revolutionise supply and lift productivity across a host of sectors. The prospect of returning to more historically normal productivity rates could help to contain political tensions.
- On the downside: recent data have disappointed across almost all major economies except the US. If the slowdown deepens, activity could surprise to the downside in 2025. In that case, we would look for central banks to cut interest rates to levels well below those set out in our base case. The danger to this risk scenario is that, if trade tariffs re-ignite inflation concerns, central banks may be somewhat cautious about leaning too aggressively into downside risks to growth.
Tail risks in the age of instability
Political disillusionment across major parts of the world combined with elevated West versus East geopolitical tensions make for an uneasy backdrop. In addition to the two-side macro risks set out above, we need to keep a close eye on five serious downside tail risks:
1. a US lurch towards extreme isolationism during Trump’s second term;
2. an uncontained tit-for-tat trade war between the US, Europe and China;
3. a spillover of the Russian-Ukraine war into a NATO member;
4. a broadening of the Israel-Palestine conflict into neighbouring countries; and
5. any attempt by China to annex Taiwan using military means.
UK: core strengths, near-term risks
Judging by underlying economic fundamentals and the mostly stable political situation, the UK setup is the most favourable since before the 2016 Brexit vote. However, near-term risks are tilted to the downside following a recent unexpected softening of domestic momentum, as well as a drop in business and consumer expectations - which had been recovering on trend up until late summer (Figure 4). If, as we expect, momentum improves in 1H25 as a planned fiscal loosening and less tight credit conditions lift demand, the UK can enjoy a sustained period of healthy economic expansion.
Core strengths can prevail over time
The UK benefits from a host of strengths, including a well-capitalised banking system that can lend into a recovering economy; businesses with high cash balances and low levels of debt that can afford to increase leverage and risk-taking (Figure 5); households with small credit balances and manageable mortgages that can bolster wage-driven spending with a period of debt expansion; and mostly well-regulated and competitive product and labour markets.
In recent times, these strengths acted as a buffer against unusual and outsized shocks, including: 1) the political and economic disruptions of Brexit in 2016-20; the global and domestic demand and supply disruptions from COVID-19 in 2020-21; and the energy-inflation and interest rate shocks in 2022-23. With this recent history mind, note that 2024 marked the first ‘normal’ year for the UK since 2015 – that is, one not defined by an unusual economic or political development.
The result was half-promising. Inflation returned to close to the Bank of England’s (BoE) 2% target amid a c.0.8% year-on-year rise in real GDP. While that growth rate is below the UK’s medium-term potential of c.1.5-1.7%, it is a step in the right direction. Business investment grew strongly, and household consumption improved. However, real household spending still lagged behind real income growth while saving rates increased - likely reflecting a greater incentive to save more at higher real rates of interest, but also a degree of lasting caution after a few tumultuous years. From a low base, housing market activity – still hampered by the 2022-23 surge in mortgage costs – rebounded (see In Focus: UK housing market on page 9). Weak global trade hurt exports and production, and construction activity remained haphazard.
Figure 4: UK consumer and business outlook
Outlook for the next twelve months. % balance. Monthly data. Source: GfK, Lloyds Bank.
Figure 5: UK nonfinancial corporations balance sheet
As a % of GDP. Quarterly data. Source: ONS, BoE
Economic outlook – Broadening expansion
As our base case, we look for improving momentum that broadens towards sectors that had been lacklustre in 2024.
We project real GDP growth of 1.4% in 2025, picking up to 1.8% in 2026. Although near-term risks are tilted to the downside, absent any new shocks, the domestic economy can build up a head of steam over the medium term. While our call is in line with consensus (1.4%) for 2025, we are above the consensus call of 1.5% in 2026. Once the feel-good factor of sustained healthy growth kicks in, momentum can go up another gear, in our view.
Real consumption should improve as real wage gains lift purchasing power, interest rates decline further, and the growing distance of time from past shocks allows households to abandon their caution, reduce saving rates, and increase credit consumption. As confidence rises, consumer demand should expand towards durable retail goods, big-ticket discretionary items such as cars and white goods, as well as home improvement (see In Focus: UK consumer fundamentals on page 10).
The outlook for investment remains positive. The government’s planned expansion of public investment should underpin multi-year gains in infrastructure spending, while recovering housing demand should encourage a step up in residential construction. While the government’s target of 1.5m new homes built by the end of parliament looks ambitious, we believe 1.2-1.3m is doable and would represent a major increase in activity. Business investment can continue to rise along its longer-term trend, but faces risks from low confidence in the Labour government after a disappointing first budget (Figure 6).
The outlook for trade and production is mixed after a long period of weakness (Figure 7). Although a broad-based fiscal and monetary loosening in 2025 coming from the US, major parts of Europe, and China should underpin a cyclical rebound in global industry, current activity is weak and the risk of rising global barriers to trade may further disrupt global supply chains and raise the costs of doing trade.
The labour market picture is complex. The BoE’s tight monetary policy since 2022 has brought an ultra-tight labour market into better balance. Although the unemployment rate remains low at 4.2%, jobs growth has slowed, vacancies have fallen from an all-time high of 1.3m in summer 2022 to c.800k in late 2024, and wage growth has moderated somewhat.
Figure 6: UK business investment
In real terms. Green dotted line shows long-run trend. 2016 = 100. Quarterly data. Source: ONS.
Figure 7: UK industrial production and exports
In real terms. Exports of goods and services. 2019 = 100. Monthly data. Source: ONS
Sustained gains in economic activity should underpin a healthy rise in labour demand that is well supported on the supply side by recent huge inflows of foreign labour. However, anti-employment policies by the Labour government cast a shadow over the outlook. Higher indirect and direct costs of hiring may contribute to modestly rising unemployment, and sudden job losses in spring 2025 are possible when employment taxes rise. Planned minimum wage increases could also impair labour demand on trend.
Mind the policy factor
The mood towards the Labour government – which campaigned on a pro-business, pro-growth ticket – has soured since it came into office in July, and especially since the 30 October budget. Is it justified? Not fully, in our view. While upcoming tax increases will - on their own - hurt employment and growth, this negative impact should be more than offset by the much larger rise in government spending. Partly financed by debt issuance, the government plans a multi-year fiscal expansion that should provide a sizeable backstop for domestic demand. The Office for Budget Responsibility (OBR) estimates that the government’s fiscal loosening will add some 0.6pp and 0.4pp to growth in 2025 and 2026 (Figure 8). Thereafter, the OBR conservatively assumes that further spending increases will be fully crowded out by compensatory declines in private activity. Assuming the OBR has overdone it, even by a bit, the UK can enjoy a sizeable fiscal tailwind for at least three years. Once the government starts spending the money and private businesses see the increase in demand, sentiment should improve.
BoE policymakers reduced the bank rate twice in the second half of 2024 to 4.75% – at a pace of one 25bp cut per quarter. Policymakers have signalled that they will likely continue to reduce the bank rate in a gradual fashion but remain data-dependent amid fears that inflation could stay stuck above the 2% target – especially while measures of domestic prices such as core inflation and services inflation remain elevated (Figure 9). In 2025, we expect three more 25bp cuts at a quarterly pace in the first, second, and third quarters to take the bank rate to 4.0%. The risks to our UK calls are skewed to the downside in the near term following the recent softness in domestic economic activity. If the drop in momentum turns out to be the start of a longer period of weakness, the BoE may need to turn more aggressive and cut faster than we project in our base case.
Figure 8: OBR impact of budget measures on GDP
Fiscal year April to March. In percentage points contribution to % YoY real GDP. Source: OBR
Figure 9: UK inflation measures
In % YoY. Core inflation (ex. energy, food and alcoholic beverages and tobacco). Monthly data. Source: ONS
