Quarterly investment outlook – Q2 2025

The global liberal trading and economic system is being reset by the US for a third time in the last 54 years, to reduce economic competition from China and increase the US manufacturing capacity. While disconcerting and certainly unpredictable, the trade war has the makings of a geostrategic shift more than those of a typical economic and financial downturn. Tariffs are more of a negotiating tool, and they should best be seen as a stop towards a new status quo, whose shape we can’t yet predict. While we expect disruption to persist, we don’t anticipate a sharp “crisis” per se, as independent central banks are fully equipped to manage market volatility and prevent it from spilling over to the real economy.

We expect growth to fall across the board, with Europe and the UK closer to a recession, as a result of lower growth pre-2025. Probabilities for a US recession have also risen, but it remains a closer call. Unemployment could move higher, and inflation remains unpredictable across the board. Our base case scenario is that macroeconomic indicators will become increasingly volatile as tariffs begin to weigh on the global economy.

Professionals across the board should make sure that their business plans and decisions capture that uncertainty. However, businesses should also be reminded that turmoil often marks the end of the status quo and can create unique opportunities for challengers.

UK economy: Higher borrowing costs and weak growth prospects have reduced the fiscal space, limiting the new administration's ability to significantly increase public investment. In addition, US tariffs are likely to reduce goods exports to the US and, indirectly, to the EU through lower growth in Europe. Tensions could increase uncertainty and cause businesses and consumers to postpone investment and consumption plans, triggering a recession. As a result, we expect UK GDP to grow below 1% this year. We expect private consumption to be the main driver of growth, as wages continue to rise in real terms and employment levels remain high. Risks to our scenario are tilted to the downside.

Consumption: We are optimistic about the developments for 2025. The fundamentals of consumption remain solid: 1) real incomes are rising, 2) the labour market is strong, 3) household balance sheets are robust and 4) wealth effects continue to be positive. We should monitor closely whether recent developments have had a material impact on consumer sentiment. If the latter is the case, then the strong fundamentals will not be reflected in consumption figures. Overall, we see household consumption expanding close to 1%.

Inflation: Headline consumer inflation surprised to the downside in March, falling to 2.6% y/y from 2.8% in February. Core CPI (excluding energy and food) eased to 3.4% y/y and services CPI slowed to 4.7% y/y from 5.0%. However, March's inflation print will be the lowest we will see for several months. Inflation is expected to accelerate due to upcoming increases in energy, water and council tax, with the Bank of England forecasting a peak of 3.7% in 3Q25. We expect slow but continued progress towards disinflation in services: leading indicators point to a slowdown in wage growth, which would be in line with core inflation of around 2.5-3% y/y by 4Q25. Headline inflation is likely to be 3% on average this year.

Interest rates: We expect the impact of tariffs and greater uncertainty in the US to lead to subdued growth around the world, resulting in lower growth and inflation in the UK. As a result, we see the BoE cutting rates three to four times over the rest of 2025, ending the year with a policy rate of 3.5-3.75%.
Labour market: As we expect economic activity to grow by around 0.5-1% in 2025, we do not expect the labour market to weaken significantly in the coming months. This means that the unemployment rate could rise by a few decimals (to around 4.5-4.7% at the end of the year), but remain below 5%.

Real estate: We expect prices to rise by around 3-4% in 2025. Affordability will improve moderately due to the combination of higher wages and lower mortgage rates, but most importantly, the stabilisation of housing supply. We believe the new demand for housing will not be matched by sufficient increased supply to moderate price increases.

In the age of a messy reduction of co-dependency between the US and China, there are times when Europe, one of the world’s biggest consumer markets, and the third largest economic block, seems less relevant, destined to watch as the global economic and military behemoths of its time fight for supremacy.  However, some investors now look to the EU as the last major bastion of the systemic global liberal trading and economic order they knew to exist before the 21 of January, and one that may end up playing a key role in how events unfold.

Instead of underperforming the US, as it would in a time of crisis, European assets are now considered relatively safer than they were before. Therefore, the (multi-trillion Euro) question is: will Europe be able to capitalise on this newfound interest and become the hub of global business in a way that America now seems to repudiate?

The structural issues are still very much relevant. So is a tough regulatory environment.

However, there are certain developments that add to the EU’s firepower

1. Germany has abandoned its nearly century-old mercantilist model, whereby it grew richer by running trade surpluses, and agreed to significantly increase its budget and expand its borrowing. This will restore some balance in the Eurozone economy.
2. After the COVID-19 pandemic, debt mutualisation gained ground. This has always been a key issue for Europe, as mutual debt and thus mutual obligations could bring EU countries closer together in times of crisis.
3. France has suggested it is willing to expand its nuclear umbrella to cover other nations, even as the US is now negotiating over the security that was previously taken for granted. Talks of a Euro-army are also in place.
4. The UK is drifting back towards its traditional European allies. While Brexit won’t be reversed, Britain and the EU improving their military and trade relationships is beneficial to both.
5. The Eurozone now has a roadmap forward. In 2024, Mario Draghi, former President of the Central Bank, wrote a report outlining Europe’s architectural flaws, while suggesting and roughly valuating solutions. This report has become central in Europe’s discussions about moving forward. This is an acknowledgement that the EU knows it needs to improve cooperation and external competitiveness and has some guidance about what it may cost.