Inflation has been a major concern for the US economy in 2024. And it looks like fears of sticky prices will continue in 2025.
“We expect a gradual deceleration 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 The Federal Reserve's 2% target on an annual basis, pressured by hotter-than-expected readings on “core” monthly price increases, which strip out volatile food and energy costs.
“Inflation is going to be driven primarily by the services side of the economy,” Luzzetti said, calling out core services like health care, insurance, and even airfares. “Shelter inflation is also still high, and although it will decrease over the next year, it is likely that it could remain a little high.”
According to the updated economic outlook from the Fed's Summary of Economic Outlook (SEP), the central bank sees core inflation hitting 2.5% next year, higher than its 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, most see core PCE moderating to 2.5% in 2025 but expect less of a slowdown in 2026, with most economists predicting a higher reading of 2.4% compared to with the Fed.
“The risks are certainly tilted in the direction of higher inflation,” Nancy Vanden Houten, lead US economist at Oxford Economics, told Yahoo Finance.
In a press conference following the Federal Reserve's final interest rate decision of the year, Federal Reserve Chairman Jerome Powell said the central bank expects “significant policy changes” but warned that the extent of the policy adjustments remained uncertain.
“We need to see what they are and what effects they have,” he told reporters at the time, adding that the Fed was “thinking about these questions” and would have a “much clearer picture” once policies' n be implemented.
For some, the picture is already clearer than not.
Nobel Prize winning economist and Columbia University professor Joseph Stiglitz said in Yahoo Finance's annual Investment Conference last month that the US economy has achieved a soft landing, where prices are stabilizing and unemployment remains low. “But that's the end of January 20,” he warned, referring to Inauguration Day.
There have been tariffs one of the most talked about promises from the Trump campaign. The president-elect has promised to impose blanket tariffs of at least 10% on all trading partners, including a 60% tariff on Chinese imports.
“It will be inflation,” Stiglitz said. “And then you start thinking about the inflationary spiral, the prices are going up. Workers will want more wages. And then you start thinking what happens if others retaliate (with u their own duties).”
FILE – Former President Donald Trump's Republican presidential nominee visits Sprankle's Neighborhood Market in Kittanning, Pa., Sept. 23, 2024. (AP Photo/Alex Brandon, File) ·THE SOCIAL PRESS
Stiglitz believes Powell will raise interest rates if inflationary pressures continue.
“You combine the higher interest rates and the retaliation from other countries, you're going to have a global slowdown,” he said. “Then you have the worst of all possible worlds: inflation and stagnation, or slow growth.”
BNP Paribas issued a grim 2025 forecast, expecting the Fed to delay its easing cycle next year amid “a significant increase in inflation from late 2025 to 2026” due to the introduction of tariffs. The company sees CPI settling at 2.9% by the end of next year before climbing to 3.9% by the end of 2026.
Meanwhile, Minneapolis Fed president Neel Kashkari categorized possible retaliation from other countries like a “tit-for-tat” trade war.which would keep inflation high over the long term.
Investors are starting to take notice of the risk. In the latest Global Fund Manager Survey from Bank of America released earlier this month, expectations oa “no landing” scenario, where the economy continues to grow but inflationary pressures persist, reaching an eight-month high.
In the United States, Congress usually sets tariffs, but the president has the authority to impose some under special circumstancesand Trump has promised to do so.
It is remains unclear what policies will be a priority once Trump takes office or if he fully commits to the promises he has already made.
“Our baseline is that we get tariffs next year, but they start relatively low and are targeted,” Luzzetti said, projecting a 20% cumulative increase in tariffs on China, as well with more levies targeted at Europe.
“Things like the general base tariff, which is this general tariff rate that Trump has threatened, we don't believe that's being implemented,” he said.
Still, the economist believes that whatever tariffs Trump chooses to implement will lead to higher inflation over time. It has been baked in zero interest rate cuts from the Federal Reserve next year for that reason.
“Our view is that inflation does not come under 2.5% next year and that the Fed would not be comfortable with that, and therefore would not keep cutting rates,” he said. “But we also have an expectation that the economy will remain quite resilient.”
“There are only a few tails off to an economy that is already enjoying solid growth momentum, and the Fed has just undertaken 100 basis points of rate cuts this year,” Luzzetti said. “All of that, we think, lays a pretty solid floor under growth over the next year.”
