Thoughts

December 13, 2024 | 16:39

Hark! The Dovish Angels Sing ... in 2025

Economist

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

Every look ahead to the coming year is a challenge, but 2025 seems particularly rife with uncertainty. Much of this has to do with a looming trade war with the U.S. given the incoming Administration’s strong protectionist views. How monetary policy plays out will depend on the evolving political stage and the data, with possible deeper rate cuts across the Euro region and the U.K.

The ECB can breathe a bit easier, with inflation nearing target. The economy, however, is slowing and policy is still restrictive, so a further 100 bps of rate cuts are pencilled in, but there are still plenty of questions. Russia’s continued invasion of Ukraine and the expanding trade war (with China and likely the U.S.) may, or may not, unify Europe. Leaders are discussing more spending on defense (to 3% of GDP) as President-elect Trump threatens to leave NATO. Europe has a trade surplus with the U.S. so Brussels hopes that by boosting U.S. LNG imports, tariffs can be avoided. Beyond that, Germany is the weakest link as it struggles to deal with the slow transition to EVs, reliance on China for key materials for the transition, an aging workforce, and an energy-intensive manufacturing sector. Relaxing the debt brake to promote investment is becoming more palatable; and after an expected February election, the new coalition government, likely led by the CDU, will make it so. Meantime, France is at a standstill with its broken parliament, as no single party has a majority. It will be challenging for the government to pass any policies or a budget that will satisfy Brussels, until a potential early presidential election. Italy’s PM Meloni is making an effort to rein in the deficit, but it helps that she has a big majority. The EUR may hit parity in Q1.

The U.K. is less concerned about tariffs as it has a small trade deficit with America. Instead, there are domestic issues. The Labour Party has a large majority and does not have to face another election until 2029, but public opinion is already taking a hit, particularly from the business community, thanks to the tax hikes in Chancellor Reeves’ budget. Employers are already dealing with the 6.7% minimum wage hike; now, there is the increase in National Insurance for their workers. Already, job vacancies declined the most in four years, and one measure of business confidence fell to a two-year low. Rumours of slower pay raises are making the rounds. But what may prevent the BoE from easing more aggressively is that the budget was not as “painful” as the government had advertised, which may augur stickier inflation. For now, we expect three cuts by the BoE, vs. four from the ECB, which would widen the spread between both policy rates, and be more GBP-supportive.

The BoJ will continue to stand out. It tightened monetary policy throughout 2024 and will continue to do so in 2025, which could help the JPY rally to ¥145 by year-end. Real wages are finally rising: businesses are stepping up thanks to PM Ishiba’s goal to lift wages by over 7% by the end of this decade. The largest union pushed for a more-than-5% pay hike this spring. Households are finally seeing real earnings growth, and should increase spending. Finally, the RBA, after staying on the sidelines in 2024, should have enough evidence of inflation returning to the 2%-to-3% target, allowing Governor Bullock to cut rates in February. The central bank sounded more dovish in December, stating that it is “gaining some confidence” that inflation is headed to the midpoint of the target. There is one job and one quarterly CPI report before the first meeting of 2025; and, they should provide enough reason for that first cut.