Will 2025 Bring Back Inflation?

At the beginning of 2024, the U.S. economy was anticipated to continue its growth trajectory, despite concerns from some experts about a potential recession. The past year has shown strong economic expansion, moderating inflation, and gains in efficiency, leading many economists and financial analysts to revise their predictions of an economic downturn. (1)

However, “soft landings”, when an economy slows just enough to curb inflation but avoids a recession, can only remain soft for so long.

As we look ahead to 2025, there are several key questions and risks worth considering as we begin the new year.

What Is Inflation?

Inflation refers to the rise in consumer prices over a set period of time, with economists generally focusing on the price changes of a wide range of goods and services which reflect what Americans typically purchase. (2)

It’s important to distinguish inflation from the actual prices consumers pay for specific goods or services. Inflation is the rate of price changes, often measured on an annual basis. (2)

Inflation has been gradually slowing since mid-2022. Factors like the resolution of COVID-19-related product shortages, cooling consumer demand after the post-pandemic spending boom, and slower wage growth due to an expanded labor force have all contributed to this decline. The Federal Reserve’s interest rate hikes have also played a role by making borrowing more expensive, which has reduced spending. (2)

How Bad Will Inflation Be in 2025?

Inflation was expected to continue drifting closer to the Federal Reserve’s target of 2% by the end of 2025, as household spending and wage increases slow further. However, some economists now believe that former President Trump’s trade and immigration policies could result in inflation remaining higher than expected into 2025 and beyond. (2)

The Fed is Still Trying to Bring Inflation Down

Inflation still remains above the Federal Reserve's preferred level. As a result, the Fed will likely need to maintain higher interest rates for longer, even though inflation has significantly decreased since its peak in 2022. (3)

After reducing interest rates by one percentage point in 2024, the Fed has indicated that it plans to implement only two quarter-point cuts in 2025, with some economists forecasting even fewer rate reductions. (3)

The Fed may still have some room to maneuver, as recent data shows that the labor market remains strong, with 256,000 jobs added in the most recent report. The Fed may not need to rush to reduce interest rates. Instead, it can maintain higher rates and rely on a healthy economy and rising wages to offset the impact of inflation. (3)

Inflation and Economic Uncertainty

The Federal Reserve’s approach highlights an important uncertainty for 2025: there is some concern that rising unemployment and inflation may persist. The Fed faces the challenge of maintaining the right balance: continuing to support economic activity while preventing inflation, which is currently around 2.4%, from spiking again. (1)

In 2025, interest rates may remain elevated in the face of slowing inflation, which is still above the Fed’s 2% target. However, the higher-rate environment may not overly burden consumers or the broader economy. (1)

Equities and Financial Markets

The outlook for 2025 is generally positive, with economic growth supported by resilient consumer spending, a steady labor market, and less restrictive monetary policy. (1)

Stock price targets are currently at historic highs following a post-rally period, which could warrant caution. Persistently high interest rates may put pressure on corporate debt levels and sectors sensitive to rates, such as housing and utilities. (1)

In addition, corporate earnings remain strong, supported by cost savings and productivity gains. While stock performance may be muted, discounted or underperforming stocks could experience a rebound in 2025. (1)

Article Sources:

(1) Nam, Rafael. “Inflation remains stubbornly high for many Americans. Could it get worse under Trump?” NPR, January 15, 2024.

(2) Davidson, Paul. “Will inflation go down in 2025 after Trump becomes president?” USA Today, November 20, 2024.

(3) Blank, Brian D. and Brandy Hadley. “Analysis: How will inflation, interest rates and the U.S. consumer fare in 2025?” PBS, December 31, 2024.