BoE and Fed poised for hawkish shift in 2025

The European Central Bank (ECB) cut interest rates by a widely anticipated 25 basis points (bps) in early December, lowering the key deposit rate to 3%, from 3.25%.  It is the ECB’s fourth cut since June. Markets are pricing in investors’ expectations of three 25bps cuts in January, March and April next year.

Notably, the ECB changed its tone, shifting from its more ‘restrictive’ position to one of greater focus on the data, which hints at further interest rate cuts in 2025.

The inflation projection for 2024 dropped to 2.4%, from 2.5% and the ECB predicts it to come down to 2.1% in 2025 and reduce to 1.9% in 2026. Overall, the ECB’s interest rate cut had a marginal impact with the euro dropping slightly before recovering while government bonds remained muted.

Back in the UK there was a slight rise in inflation with November’s Consumer Prices Index (CPI) increasing to 2.5% from 2.3% in October. Core inflation (excluding food and energy) rose to 3.5% from 3.3% in October. Services is a key driver of inflation in the UK and is running at 5%.

The BoE is wary that services inflation could be sticky, especially as earnings, a significant driver of services inflation, rose more than expected in October. 

Within services, there are pockets of inflation, like rents in the housing category, which are running north of 7% per year.  Another consideration for the BoE is the hike in the national minimum wage and employer national insurance (both from April) announced in the Autumn budget could put pressure on companies to raise prices to maintain profits. As such we expect the next BoE interest rate cuts in February and May this year. 

In the wake of the significant developments, (the UK budget and US election), over the past few months, the BoE kept interest rates unchanged at 4.75%. 

Higher than expected inflation, due to higher core goods and food prices, was offset by signs that UK GDP growth has shown signs of stagnation.  The bank’s decision underscores a cautious yet flexible stance, aiming to balance inflation control with sustainable economic growth and employment stability. 

Overall, the BoE has cut interest rates twice in 2024 and we expect further cuts in 2025.

The Federal Open Market Committee (FOMC) voted to cut interest rates by 25bps to 4.5%. It’s the third consecutive cut  bringing the total to 1% in 2024, following a 50bps cut in September and a 25bps reduction in November. 

In its new projections, the FOMC indicated it’s likely to adopt a cautious approach to future interest rate cuts as its focuses on inflation. Investors had priced in three or four cuts in 2025, but the FOMC dot plot (a chart that summarises its outlook for rates) indicates a total of just 50bps of rate cuts for this year. 

The US economy is currently resilient. The labour market rebounded in November following disruptions in October, and core CPI inflation at or above 0.3% month-on-month for the last four months.

However, uncertainty over the inflationary effects of the incoming Trump administration weighed on the committee. They revised their economic projections for growth and inflation from 2.4% to 2.5%. It’s clear the FOMC believe it will take longer than previously expected for inflation to return to the target level. 

If you have any questions about how these announcements can impact your portfolio and investment decisions, please contact your usual Evelyn Partners adviser.