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Is something bad on the way? That is one of the questions posed in the international outlook for 2025, from the Munich-based giant financial group, Allianz, and it will ring a bell for many people.
The year 2024 was a mixed one for the global economy, disappointing for the UK and most of Europe, but pretty positive for America. Indeed, the most important US share index, the S&P 500, ended the year up 24 per cent on the year, a dramatically better performance than that of the FTSE 100, up just under 6 per cent.
Share prices are an imperfect indicator of economic performance, but they do convey the prevailing mood of investors, and the plain fact is that in the US they have ended the year on a big up.
Transatlantic woes
But if there is a sense of unease around – that discomfort noted by Allianz – it is different here and in Europe from the concerns in and about America. Here in the UK the worries are mostly about how the economy will react to the tax increases that come in through 2025, and in particular how companies respond to the rise in their national insurance contributions that start in April.
The economy grew well during the first part of last year, but has flatlined during the second half. Might these additional taxes push it into recession?
In the US the situation is different, with the most important single question being whether the booming equity markets can sustain their extraordinary performance, or is this a bubble that will pop? If the latter, that too might trigger a recession, and that would have knock-on effects for the rest of the world.
Economists are making their predictions, which for the UK means modest growth. The OECD has forecast that it will be 1.7 per cent, the IMF 1.5 per cent. That is not bad by European standards.
A House of Commons research paper that came out just before Christmas noted that this was higher than any major European economy, and behind only the US and Canada. The outlook for the US is a bit better, with both the OECD and Goldman Sachs expecting 2.5 per cent, against a consensus of 1.9 per cent. But all forecasts need to be taken with a pinch of salt, for past experience shows that they can be totally wrong.
Acceptable inflation
So what should we look for that will help tell us whether these reasonably benign forecasts are going to be pretty much spot on, or whether there is indeed something bad around the corner?
If you want one single indicator, it is inflation. Does it come back down to 2 per cent or below? Naturally, inflation will vary from country to country, and it depends on the measure you take.
Here in the UK we have three main inflation statistics, the Consumer Price Index, which was 2.6 per cent in November, the CPIH (the H because it includes the cost of owner-occupied housing), which was 3.5 per cent, and the Retail Price Index, which was 3.6 per cent. But the broad trends of inflation follow a pattern that is common to just about the entire developed world. Put simply, at the beginning of last year it was coming down everywhere, it reached 2 per cent or thereabouts in the summer, then it started to climb again.
It looks as though it will rise further through the spring, but then, maybe, will start to fall so that by the end of the year it will be back to 2 per cent. Why does two per cent matter? Well, it’s the target for the main central banks, but also seems to be the number that is socially acceptable in wealthy countries.
People seem to like a bit of inflation, as it makes them feel richer and may make it easier to adjust relative prices and wages. But as we have seen they really hate it when prices sizzle upwards as they did over the past three years.
If inflation doesn’t climb too much, then settles back down, we can expect central banks to carry on cutting their interest rates, and for longer-term borrowing costs to ease back. That is important because long-yields affect everything, including the cost at which we can get fixed-term mortgages and the Government can finance the National Debt.
And if inflation does go back up? That’s not good. Higher borrowing costs would tank the economy, here and everywhere.
Political chaos
You could see this possibility in political terms. Here, it would destroy the economic plans of Rachel Reeves. In the US, it would lead to a market crash that would destroy the idea that Donald Trump was a competent steward of the US economy. But this is not really about politics. It is about the generation of wealth – real wealth, not paper wealth – in Western democracies.
We know that our economies are resilient. They have had a lot thrown at them in the five years since the pandemic struck, and they have pulled through in OK shape. So they will recover. But whether 2025 turns out to be a year of decent progress, as the official forecasts suggest, or whether there is something bad on the way, will turn more than anything else, on whether the beast of inflation stays locked in its cage.
So, you might reasonably ask, what does all this mean for investors? The general rules always apply: that investors should not try to be too clever, should in general have most of their money in global equities (which means mostly in the US), and that dividends or interest should be reinvested so that the magic of compound interest will build their wealth whatever happens in the short-terms to markets.
But having said that, I ought to add my own feelings about markets this year… and acknowledge that I got last year wrong!
I was wrong…
I had expected there to be a general realignment of equity investment to value rather than growth, so the share prices on the high-tech giants of America would move sideways or down and the more boring sectors on both sides of the Atlantic would flourish. Wrong. Apple is worth nearly $4trn (£3.1trn) and hit a record high a few days ago, and while the UK markets did well in the first half of the year, they went backwards in the second.
I also expected long-term bond yields to be flat, whereas they have risen sharply in response partly to the concerns about inflation noted above, but also reacting to rising US and UK fiscal borrowing.
Now, I am reasonably confident about UK share markets, mostly because they are still undervalued, but also because nearly all the big companies are global entities. I do feel there is a real risk of the US equity bubble bursting, and the price of the most flaky assets (including Bitcoin) collapsing. But maybe there can be a year of sideways movements, rather than a crash.
As for bond yields, common sense says they may go up a bit, but that really does depend on inflation coming back down. A recession would do that job, but no-one in their right mind should wish for that.
House prices
Finally, what will happen to the price of what for most Britons is their biggest asset, their home?
I was right last year in expecting an average rise of around 5 per cent. The official numbers won’t come out for a bit, but Halifax reckoned prices were up 4.8 per cent year-on-year in November. Next year? Well, it comes back to inflation again.
There will be some cuts in interest rates by the Bank of England, but their ability to do so will be limited by what happens to consumer prices. My guess is this will be a flat year for housing overall, maybe up a bit, but nothing dramatic. On a long view UK homes are a good investment. People need them and we don’t build enough. But the easy money is over, which if you think about it, is no bad thing.
And if something bad does happen? Back to the usual rules: stay invested, diversify risk and wait for the inevitable rebound.
This is Armchair Economics with Hamish McRae, a subscriber-only newsletter from The i Paper. If you’d like to get this direct to your inbox, every single week, you can sign up here.