Unexpected Growth, Cooling Inflation and Caution Ahead for Markets
At the start of 2025, many feared that Donald Trump’s tough tariff plans would weaken the US economy. So far, that hasn’t happened. Instead, the year ended strongly, with new data showing the US economy grew by an impressive 4.3% in the third quarter – the fastest growth since 2023 and well above expectations. While consumers remain cautious, much of this growth has been driven by businesses investing heavily in new technologies, particularly Artificial Intelligence (AI).
Looking ahead to 2026, the economic backdrop remains supportive, with government spending and lower interest rates helping to support markets. That said, after a very strong year for shares and other higher-risk investments, some areas now look overheated. The Bank for International Settlements (the “central bank for central banks”) has recently warned that both gold and US shares are showing signs of being priced at unsustainably high levels.
Interest rate cuts continue as UK inflation cools, though economic growth remains fragile
- The Bank of England cut the base rate to 3.75%, following a vote of 5-4 in favour of the cut from the Monetary Policy Committee. Comments from Governor Andrew Bailey stated that rates are likely to continue a ‘gradual downward path’, but that further cuts would ‘become a closer call’.
- UK inflation eased in November to 3.2%, from 3.6% in October, below forecasts of 3.5%. Both the core rate of inflation, which excludes energy and food prices, and services inflation, cooled, helping to bring down the headline number.
- The UK public’s median expectation for the rate of inflation in the year ahead fell to 3.5% from 3.6% in August, according to the Bank’s quarterly inflation attitudes survey. For inflation in the longer-term (5+ years), expectations fell to 3.7% from 3.8%.
- UK GDP contracted by 0.1% in October, after falling by a similar amount in September, with construction being the worst-performing sector. FactSet economists forecasted a 0.2% expansion. GDP also fell 0.1% in the three months through October.
The Federal Reserve eases further, but inflation and jobs data keeps policy divided in the US
- The Federal Reserve (Fed) delivered its third straight interest rate cut of 0.25% in December, and while the headlines hinted at drama, the dissent among officials was more muted than markets expected. Fed Chair, Jerome Powell, noted that the Fed funds rate is “within a broad range of estimates of its neutral value” and that policymakers are “well positioned to wait and see how the economy evolves.”
- Three policymakers dissented for the first time in six years, with two officials favouring no change to the policy rate and one preferring a 0.5% cut. The Fed’s policy statement also included language that has previously signalled a pause in policy actions. It noted that policymakers “will carefully assess incoming data” to determine “the extent and timing of additional adjustments to the target range.”
- The Fed’s preferred inflation measure – the personal consumption expenditures (PCE) index – increased 0.3% month-on-month in September, in line with August’s reading. Core PCE, which excludes volatile food and energy prices, increased 0.2%. The original release of the September data was delayed due to the federal government shutdown, and the Bureau for Economic Analysis has not yet announced a rescheduled release date for October’s data.
Growth improves as the European Central Bank holds the line
- The European Central Bank saw a unanimous vote to hold its interest rate steady at 2.00%, whilst also increasing its growth projections from those announced in September. Growth forecasts have been revised upwards to 1.4% in 2025, 1.2% in 2026, and 1.4% in both 2027 and 2028.
- Annual headline inflation in the eurozone increased to 2.2% in November from 2.1% in the previous month. Falling energy prices partly offset higher services costs. Core CPI remained at 2.4%.
- The eurozone’s GDP increased by 0.3% in the third quarter, helped by a rebound in fixed investment that caused an upward revision from the previous estimate of 0.2%. France and Spain drove the expansion, while Germany’s economy lagged.
2025 proved to be an excellent year for investors. Global stock markets rose far above their long-term average.
Despite weak economic growth at home, the UK stock market performed exceptionally well, helped by strong returns from defence companies, banks and mining stocks. China and Latin America also delivered strong gains, showing that markets can perform well even when economic news is disappointing.
Bond markets were more mixed. Despite interest rate cuts, longer-term bond yields in both the UK and US ended the year slightly higher, reflecting ongoing uncertainty about inflation and government borrowing.
Precious metals had an extraordinary year. Gold reached new highs, while silver rose even more sharply, driven by a weaker US dollar, geopolitical tensions and investor demand for perceived “safe havens”.
In conclusion
As we move into 2026, the global economic backdrop remains broadly supportive, with easing inflation and lower interest rates helping to underpin markets. However, after a year of exceptional returns across many asset classes, pockets of optimism are starting to look stretched and volatility is likely to return. In this environment, staying diversified, disciplined and focused on long-term objectives remains key.
Short-term market noise can be unsettling, but history shows that well-constructed portfolios and a measured approach are the most effective way to navigate periods of uncertainty.