Inflation has been one of the biggest concerns for the US economy in 2024. And it looks like the fear of price rigidity will continue into 2025.
“We expect a gradual slowdown from where we are now, but to levels that are still uncomfortably high for the Fed,” Matthew Luzzetti, chief economist at Deutsche Bank, told Yahoo Finance in an interview.
So far this year, inflation has been subdued but remains stubbornly above the Federal Reserve’s 2% annualized target, pressured by higher-than-expected monthly “core” price increase figures, which are offsetting volatile food and energy costs.
In November, the core personal consumption expenditure index (PCE) and the core consumer price index (CPI), both closely monitored by the central bank, rose 2.8% and 3.3% respectively from the previous year period.
“Inflation will be driven primarily by the services side of the economy,” Luzzetti said, citing core services like health care, insurance and even airline tickets. “Shelter inflation is also still high, and while it will decline over the next year, it is likely to remain somewhat elevated.”
According to updated economic forecasts from the Fed’s Summary of Economic Projections (SEP), the central bank expects core inflation to reach 2.5% next year, higher than the previous projection of 2.2%, before cooling to 2. 2% in 2026 and 2.0% in 2027.
This is largely in line with current Wall Street projections. Of the 58 economists surveyed by Bloomberg, the majority see core PCE moderating to 2.5% in 2025, but expect less of a slowdown in 2026, with the majority expecting a higher 2.4% compared to the Fed .
“The risks are certainly tilted toward higher inflation,” Nancy Vanden Houten, chief U.S. economist at Oxford Economics, told Yahoo Finance. “Much of the risk comes from the possibility of certain policies being implemented under the Trump administration on tariffs and immigration.”
Newly elected President Donald Trump’s proposed policies, such as high tariffs on imported goods, tax cuts for businesses and curbs on immigration, are seen by economists as potentially inflationary.
These policies could further complicate the Federal Reserve’s stance on interest rates.
At a press conference after the final interest rate decision of the year, Fed Chairman Jerome Powell said the central bank expects “significant policy changes” but warned that the extent of policy adjustments remains uncertain.
“We have to see what they are and what effects they have,” he told reporters at the time, adding that the Fed is “thinking about these questions” and will have “a much clearer picture” once the policy is implemented.
For some, the picture is clearer than not.
Nobel Prize-winning economist and Columbia University professor Joseph Stiglitz said last month at Yahoo Finance’s annual Invest conference that the U.S. economy has reached a soft landing, with prices stabilizing and unemployment remaining low. “But that ends on January 20,” he warned, referring to Inauguration Day.
Tariffs are one of the most talked-about promises of Trump’s campaign. The president-elect has pledged to impose blanket tariffs of at least 10% on all trading partners, including a 60% tariff on Chinese imports.
“It will be inflationary,” Stiglitz said. ‘And then you start thinking about the inflation spiral, prices going up. Workers will want higher wages. And then you start thinking about what happens when others take revenge. [with their own duties].”
FILE – Former Republican presidential candidate Donald Trump visits the Sprankle Neighborhood Market in Kittanning, Pennsylvania, September 23, 2024. (AP Photo/Alex Brandon, File) ·ASSOCIATED PRESS
Stiglitz believes Powell will raise rates if inflation pressures persist.
“When you combine higher interest rates and retaliatory measures from other countries, you get a global slowdown,” he said. “Then you have the worst of all possible worlds: inflation and stagnation, or slow growth.”
BNP Paribas gave a gloomy outlook for 2025, expecting the Fed to pause its easing cycle next year amid a “substantial increase in inflation from late 2025 to 2026” due to the rollout of rates. The company expects the CPI to reach 2.9% by the end of next year, before rising to 3.9% by the end of 2026.
Meanwhile, Neel Kashkari, chairman of the Minneapolis Fed, categorized a possible retaliation by other countries as a tit-for-tat trade war, which would keep inflation high in the long run.
Investors are starting to wake up to the risk. In Bank of America’s latest Global Fund Manager Survey, released earlier this month, expectations of a “no landing” scenario, in which the economy continues to grow but inflationary pressures persist, reached an eight-month high.
In the United States, Congress typically sets tariffs, but the president has the authority to impose certain tariffs under special circumstances, and Trump has promised to do so.
It remains unclear which policies will be prioritized once Trump takes office, or whether he will fully adhere to the promises he has already made.
“Our starting point is that we will have tariffs next year, but they will start relatively low and targeted,” said Luzzetti, predicting a cumulative 20% increase in tariffs for China, in addition to more targeted duties for Europe.
“Things like the universal base rate, this blanket tariff rate that Trump has threatened, we don’t think that will be implemented,” he said.
Still, the economist believes that whatever tariffs Trump chooses will lead to higher inflation over time. For that reason, he has implemented a zero Federal Reserve interest rate cut next year.
“Our view is that inflation will not fall below 2.5% next year and the Fed would not be comfortable with that and therefore would not continue to cut rates,” he said. “But we also expect the economy to remain quite resilient.”
And the US economy has proven resilient through 2024. Retail sales again exceeded expectations for the month of November, GDP remains strong and above trend, the unemployment rate continues to hover around 4% and despite future uncertainty and the bump has fallen to 2%, inflation is subdued.
“There’s quite a bit of tailwind for an economy that already has solid growth momentum, and the Fed just delivered 100 basis points of rate cuts this year,” Luzzetti said. “All of that will, in our view, provide a pretty solid foundation for growth in the coming year.”
Alexandra Canal is a senior reporter at Yahoo Finance. Follow her on X @allie_canal, LinkedIn, and email her at alexandra.canal@yahoofinance.com.
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