United States Federal Reserve will ease into interest rate cuts next year, taking a cautious approach as inflation remains persistent and the incoming Trump administration introduces new policies.
Expectations for inflation and economic growth in 2025 have been revised higher, forcing the Fed to hold back from aggressive rate adjustments.
The core personal consumption expenditures (PCE) price index, the Fed’s favored measure for tracking inflation, is now projected to rise by 2.3% on average in 2025, up slightly from last month’s estimate of 2.2%.
Economists expect inflation pressures to remain steady into the first quarter of 2025, driven by strong consumer spending and policy changes from the new administration.
U.S President Elect Donald Trump’s proposed policies, including steep tariffs and tax cuts, have amplified concerns over inflation. Economists are already preparing for a 30% increase in tariffs on Chinese imports, with the president-elect also considering a 20% tariff on all imports.
These measures are expected to push up prices for consumers and businesses. In addition to tariffs, mass deportation policies and tax reforms aimed at boosting demand could further stoke inflation.
Businesses are rushing to stock up on goods before the tariffs take effect, with higher imports projected through early 2025.
Projections for economic growth have also changed. Gross domestic product (GDP) is now expected to grow by 2% in 2025, up from earlier predictions of 1.8%.
The improved outlook stems from an anticipated increase in corporate spending and investment, particularly in sectors that delayed expansion due to political uncertainty in 2024.
The Federal Reserve though, appears cautious. While a December rate cut is still widely expected, Fed officials have signaled they may pause cuts in January, keeping rates within a 3.25% to 3.5% range for most of 2025.
Investors have adjusted to this stance, with futures markets slashing expectations for substantial rate reductions next year.
The U.S. labor market remains a cornerstone of the Fed’s measured approach. Payroll growth, while slowing, is expected to average 126,000 jobs per month in 2025, compared to 172,000 this year. Unemployment rates remain low, and steady job creation has given the central bank breathing room to hold off on aggressive monetary easing.
Inflation, however, continues to complicate matters. October’s PCE reading, a key indicator for the Fed, showed a 0.3% increase in core prices month-over-month, with a year-over-year rise of 2.8%. Chair Jay Powell recently called inflation trends “bumpy,” cautioning against overestimating progress.
Deutsche Bank economists also revised their forecasts, predicting PCE inflation to hover at or above 2.5% throughout 2025 due to tariff pressures.
Investors have responded to these realities by scaling back expectations for rate cuts. Futures market data indicates just a 10% chance of rates falling by a full percentage point by mid-2025, a steep drop from the 50% probability reported four weeks ago.
The likelihood of a quarter-point cut in December still stands at 60%, but broader optimism about deeper cuts has faded.
Inflationary concerns are not limited to the U.S. The European Central Bank (ECB) is also grappling with similar issues. Inflation in the Eurozone jumped to 2.4% in October, up from 1.8% the previous month, raising expectations for rate cuts in December.
Core inflation is projected to rise to 2.8% year-over-year. Despite these pressures, weak economic activity across the bloc has increased the probability of a larger 0.5 percentage point rate reduction.