Inflation has been a major concern for the US economy in 2024. And it looks like fears about price stickiness will continue into 2025.
“We expect a gradual slowdown from where we are, but to levels that are still uncomfortably high for the Fed,” Deutsche Bank chief economist Matthew Luzzetti told Yahoo Finance in an interview.
So far this year, inflation has moderated but remains stubbornly above the Federal Reserve’s 2% annual target, pressured by higher-than-expected readings on monthly “core” price increases, which exclude volatile food and energy costs.
In November, the core Personal Consumption Expenditure (PCE) index and the core Consumer Price Index (CPI), both closely watched by the central bank, rose 2.8% and 3.3%, respectively, compared to the period of the previous year.
“Inflation will be driven primarily by the services side of the economy,” Luzzetti said, highlighting basic services such as health care, insurance and even airline tickets. “Housing inflation also remains high and, although it will decline over the next year, it is likely to remain somewhat elevated.”
According to updated economic forecasts from the Federal Reserve’s Summary of Economic Projections (SEP), the central bank sees core inflation reaching 2.5% next year, up from its previous projection of 2.2%, before cooling to 2.2% in 2026 and 2.0% in 2027.
This largely aligns with current Wall Street projections. Of the 58 economists surveyed by Bloomberg, most believe core PCE will moderate to 2.5% in 2025, but they do expect a smaller slowdown in 2026, with most economists anticipating a higher reading of 2.4%. compared to the Federal Reserve.
“The risks certainly lean in the direction of higher inflation,” Nancy Vanden Houten, senior 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.”
Economists consider President-elect Donald Trump’s proposed policies, such as high tariffs on imported goods, tax cuts for corporations and restrictions on immigration, to be potentially inflationary.
Those policies could further complicate the Federal Reserve’s path forward on interest rates.
At a news conference following the Federal Reserve’s latest interest rate decision of the year, Federal Reserve Chair Jerome Powell said the central bank expects “significant policy changes” but warned that the scope of policy adjustments remains uncertain.
“We need to see what they are and what effects they have,” he told reporters at the time, adding that the Fed is “thinking about these issues” and will have “a much clearer picture” once the policies are implemented.
For some, the picture is already clearer than that.
Nobel Prize-winning economist and Columbia University professor Joseph Stiglitz said at Yahoo Finance’s annual Invest conference last month that the U.S. economy has achieved a soft landing, with prices stabilizing and unemployment continuing. being low. “But that ends on January 20,” he warned, referring to inauguration day.
Tariffs have been 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 inflationary spiral, prices going up. Workers will want more wages. And then you start thinking about what will happen if others retaliate.” [with their own duties]”.
FILE – Former Republican presidential candidate Donald Trump visits the Sprankle Neighborhood Market in Kittanning, Pa., Sept. 23, 2024. (AP Photo/Alex Brandon, File) ·ASSOCIATED PRESS
Stiglitz believes Powell will raise interest rates if inflationary pressures persist.
“If you combine higher interest rates and retaliation from other countries, it will lead to a global slowdown,” he said. “Then we have the worst of all possible worlds: inflation and stagnation, or slow growth.”
BNP Paribas issued a gloomy outlook for 2025, expecting the Federal Reserve to pause its easing cycle next year amid a “substantial rise in inflation from late 2025 to 2026” due to the implementation of tariffs. The company forecasts that the CPI will settle at 2.9% at the end of next year before rising to 3.9% at the end of 2026.
Meanwhile, Minneapolis Federal Reserve President Neel Kashkari called possible retaliation from other countries a “tit-for-tat” trade war, which would keep long-term inflation elevated.
Investors are starting to realize the risk. In Bank of America’s latest Global Fund Manager Survey released earlier this month, expectations for a “no landing” scenario, in which the economy continues to grow but inflation pressures persist, hit an eight-month high .
In the United States, Congress typically sets tariffs, but the president has the authority to impose certain tariffs in special circumstances, and Trump has promised to do so.
It is not yet clear what policies will be a priority once Trump takes office or whether he will fully commit to the promises he has already made.
“Our baseline is that we will have tariffs next year, but they will start relatively low and targeted,” Luzzetti said, projecting a cumulative 20% increase in tariffs on China, plus more targeted levies on Europe.
“Things like the universal benchmark tariff, which is this across-the-board tariff rate that Trump has threatened, we don’t think will be implemented,” he said.
Still, the economist believes that any tariffs Trump decides to implement will lead to higher inflation over time. For that reason, he has lined up zero interest rate cuts by the Federal Reserve next year.
“Our view is that inflation will not go below 2.5% next year and that the Fed would not be comfortable with that and therefore would not continue to cut rates,” he said. “But we also have the expectation that the economy will continue to be quite resilient.”
And the US economy has shown resilience throughout 2024. Retail sales once again exceeded estimates for the month of November, GDP remains strong and above trend, the unemployment rate continues to hover around 4% and , despite future uncertainty and its bumpy path towards 2%, inflation has moderated.
“There are a fair amount of tailwinds for an economy that is already receiving solid growth momentum, and the Federal Reserve just embarked on 100 basis point rate cuts this year,” Luzzetti said. “We think all of that sets a pretty solid floor for growth over the next year.”
Alejandra Canal He 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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