As we now enter 2025, it’s safe to say that all eyes will not only be on the incoming President of the United States, Donald Trump, but also on major monetary policy makers such as the FED (Federal Reserve System) and whether they will indeed continue to cut interest rates.
Ever since the global Coronavirus pandemic in 2020, it’s safe to say that financial markets and global economies have been turbulent to say the least. As a result of financial uncertainty and double-digit inflation, the FED were forced to step in and initiate a series of interest rate hikes to tackle inflation.
While these interest rate hikes were designed to reduce inflation, they had a negative impact on the markets, businesses, and global economies in general, with other monetary policy makers such as the ECB (European Central Bank) and the BoE (Bank of England) following suit.
After much delay, and an increasing risk of the US slipping into recession, the FED finally cut interest rates in late 2024, and are predicted to do so again in 2025. With new forecasts indicating that fewer rate cuts may be on the horizon, what does this mean for the markets and global economies?
Why Were Interest Rates Increased?
Following the global pandemic in 2020, inflation began creeping dangerously high. Inflation is used to measure how much goods and services increase in price over a specific period of time, usually a year.
Inflation basically tracks and monitors how much everyday goods, products, and services cost. This could be the average price of a cart full of groceries for the average household each week, or for the cost of services such as a manicure. The higher inflation is, the more expensive everyday goods and services are. This in turn means that everyday costs of living are also more expensive.
The markets and global economies don’t have inflation that is too high, or inflation that increases too quickly. The higher inflation is, the more expensive it costs to live which means that households will have less disposable income. Less disposable income means people spend less, which harms the economy and increases the risk of recession.
In June 2022, inflation in the U.S peaked at a whopping 9.1%. Things were similar in other parts of the globe, with UK inflation peaking at 11.1% in October 2022, and Eurozone inflation peaking at 10.60% in that same year and same month.
To not only prevent inflation from increasing any further, but also to help bring inflation down, the FED and other monetary policy makers, initiated a series of interest rate hikes between 2022 and 2024.
How Does Increasing Interest Rates Tackle Inflation?
While there is a lot more to it than the following, when central banks increase interest rates, they do so to control inflation. On the flipside, when the economy is stagnating, interest rates will be cut in an attempt to speed up economies.
As counterintuitive as it sounds, the main objective of hiking interest rates is to prevent people from spending as much money, as overspending too quickly is one of the primary driving forces of inflation. If homeowners, businesses, and any other people paying any form of interest suddenly go from paying 0.5% interest, to 5.50% interest, this is quite the increase.
Not only does it mean people have less disposable income, it also increases borrowing costs so people find it harder to take out loans and credit. At its peak in 2023, the FED hiked interest rates in the US to 5.25% – 5.50%, 5.33% to be precise. This did not change until September 2024, when they finally cut rates by .50%.
In November and December, two more .25% cuts were implemented.
Fewer Interest Rate Cuts on the Horizon?
In 2022 and 2023, the mere mention of the words ‘inflation’ and ‘interest rates’ sent the markets into turmoil. 2022 saw us enter a bear market, and while 2023 was marginally better, the markets were hardly buoyant.
While there were plenty of factors at play here, Russia’s invasion of Ukraine, rising energy prices, Liz Truss’ mini-budget, the last remnants of Covid-19, and political unrest to name but a few, it was the prospect of high interest rates that really spooked the markets and triggered a number of sell-offs.
The markets do not like uncertainty at the best of times, especially when it comes to interest rates. From an investment standpoint, high interest rates are bad news because it means businesses will be spending more, and will therefore not be as profitable.
As the BoE, the ECB, and finally the FED, decided to cut interest rates, generally the markets responded favorably and there were plenty of green days. Initially, the FED was forecast to initiate four further .25% rate cuts in 2025, meaning interest rates for 2025 would be reduced by 1%. However, those numbers were revised in December 2024, and only two .25% cuts are now expected.
Global Economic and Financial Market Forecasts
So, with fewer interest rate cuts now expected in 2025, what could this mean for the financial markets and global economies?
Well, GDP growth remains robust, the labor market is also looking strong, but inflation once again may be rearing its ugly head, as it is looking to be more stubborn than first anticipated. This is the main reason for the FED’s interest rate cuts now predicted to be 50% of what they were thought to be initially.
Developing countries should see their economies benefit from growth of between 1.25% and 1.75%. Emerging economies, however, are predicted to grow between 3.5% and 4% for the year.
In terms of growth globally, experts predict a modest expansion of 2.5%. This is largely predicted to be influenced by higher import tariffs within the U.S market, particularly involving goods imported from China.
The Trump Administration is expected to impose additional tariffs of between 10% and 60% on select goods imported from China, though tariffs on goods imported from other nations are not out of the question. If this does indeed happen, expect other nations to do the same, as this will very much be a case of tit for tat.
Should another trade war between the U.S and China breakout, this could result in a 0.6% decline in growth within China. This is based upon China devaluing its currency, the Chinese Yuan, much like it did between 2018 and 2020.
Across Europe, U.S tariffs imposed by Trump upon the Eurozone, would likely result in a reduction of growth of around ½ percent.
Overall, however, we can expect modest global growth of around 2.5%, driven in large by emerging market economies. The biggest cause of uncertainty, however, looks to be the reported tariffs imposed by the Trump Administration.