Central Banks Set the Stage for a Measured Approach to 2025

Exclusive insight for TMI subscribers! Northern Trust Asset Management share a monthly market commentary for treasurers.

Eurozone Market Update

The ECB cut rates by 25 bps to 3% in December. There had been some initial speculation that the ECB could opt for a 50 bps cut, but more recent data - including CPI, euro-area growth, and wage negotiations - moved market consensus to a 25 bps cut. Updated Eurosystem projections revised GDP growth for 2025 down to 1.1% from 1.3%, and core inflation to 2.3% from 2.8%, signalling a softer outlook. The policy statement stressed that most measures of underlying inflation suggest that it will settle at around the ECB’s 2% medium-term target on a sustained basis. ECB President Christine Lagarde highlighted downside risks to growth and inflation, citing uncertainty around US trade policies. While the disinflationary process is “well on track,” the subdued near-term outlook for growth and employment remains an issue. The ECB softened its forward guidance, removing references to restrictive rates, and reiterated its data-dependent, meeting-by-meeting approach.

_{Source: Bloomberg, data as of 31 December 2024}

UK Market Update

The BoE’s Monetary Policy Committee (MPC) held rates at 4.75% in December. The vote was split 6-3 in favour of the pause, with three members preferring a 25 bps cut. We categorise this as a dovish hold. Persistent domestic inflation and wage growth offset concerns over the UK’s slowing economic momentum. Services inflation remained elevated at 5%, driven by wage growth accelerating to 5.2%. While inflation risks are easing, progress is slower than desired. The labour market appears balanced, with wage pressures expected to moderate, aligning with forecasts of 2025 pay settlements at 3-4%. Economic headwinds persist in the UK, with GDP contracting 0.1% in October. This contraction reflects uncertainties from recent fiscal policies, including tax hikes and an increase in employer National Insurance contributions, prompting businesses to consider raising prices to offset higher costs. This could potentially exacerbate inflationary pressures.

_{Source: Bloomberg, data as of 31 December 2024}

US Market Update

The Fed unanimously cut the federal funds rate by 25 bps, aligning with expectations following September’s 50 bps “recalibration.” The policy statement remained essentially unchanged, with minor modifications. “Labour market conditions have generally eased” replaced the previous characterisation of slowing job gains. Additionally, the phrase about gaining “further confidence” in inflation’s sustainable decline toward 2% was removed, reflecting the committee's view that this condition had been met. Chair Jerome Powell clarified that this was not a signal but an acknowledgement of meeting the rate-cut threshold. Powell emphasised a data-driven, meeting-by-meeting approach, noting that while some economic risks had diminished, the labour market didn’t need significant weakening to return inflation to 2%. He stressed patience, stating, “Nothing in the data suggests the Committee needs to hurry.”

_{Source: Bloomberg, data as of 31 December 2024}

Looking Ahead

The three monetary policy meetings in December did little to change our view for 2025, and diverging central bank policies remain our key focus for 2025. In the US, the new administration’s policy initiatives and the subsequent economic and inflationary impacts will be key for determining which of our three scenarios – soft landing, reflation, or supply restraint – pan out. Europe faces downside risks from domestic and external factors, making consecutive ECB rate cuts likely until they reach an estimated neutral rate of around 2%. However, a more aggressive pace or cuts below neutral remain possible. The BoE will focus on key economic data, particularly services and wage inflation. The recent budget and policy changes from the US administration will also influence growth and inflation in 2025. We expect the BoE’s path to align with a quarterly easing cadence during policy reviews.

Chart of the Month

_{Source: Bloomberg as of 31 December 2024}

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