In our latest House View, “2025 Global Economic Outlook (I),” we assessed the United States and China’s economic performance this year and offered our forecasts for 2025. We note that both economies confront significant hurdles linked to policy shifts and structural changes. Rather than focusing on the exact timing of rate cuts, it is more important to understand the broader policy direction for medium- to long-term investment strategies. The Federal Reserve faces a difficult environment in 2025, given the need to balance economic growth, tariffs, inflation, and deficits. Today, we expand our analysis to include perspectives on Japan, Europe and the UK.

Japan

In 2025, Japan is projected to advance toward a "normal" economy, with the trajectory of the "three types of hikes"—price, wage, and interest rate increases—becoming more firmly established. This development aligns with the Bank of Japan's objective of fostering a sustainable virtuous cycle between wages and prices. Key milestones include:

• Price increases: entering the fourth consecutive year
• Wage growth: continuing into the third consecutive year
• Interest rate hikes: progressing into the second consecutive year

The Four Channels of the Wage-Price Virtuous Cycle:

1. Wage increases passed on to selling prices (Wages → Prices)
2. Wage increases supporting consumption (Wages → Prices)
3. Rising labor share of income (Prices → Wages)
4. Growth in real wages (Prices → Wages)

In Japan, two key channels are now at work. Channel 1 is when wage increases lead to higher selling prices (Wages → Prices). Channel 3 is when rising prices, in turn, boost the labor share of income (Prices → Wages) because workers demand pay raises to keep up with living costs. Although these channels pull in opposite directions, they work mutually and create a cycle that prompted the Bank of Japan to raise interest rates. Data from FY2024 suggests this wage-price cycle is taking hold: base wages are rising, and higher labor costs have pushed corporate service prices up. This shows how wage hikes feed directly and indirectly into prices—especially in labor-intensive service sectors—and how rising prices reinforce wage demands, forming a self-reinforcing loop.

We expect Channel 4 to activate in 2025 as real wage growth turns positive, supported by nominal wage growth of 2-3% and CPI inflation easing to 2.3%. Sustained real wage growth will depend on labor productivity improvements, driven by increased software investment to address labor shortages. Once Channel 4 functions, it will boost Channel 2 by supporting consumer spending, reinforcing the wage-price virtuous cycle and embedding price, wage, and rate hikes, guiding Japan toward a "normal" economy in 2025.

Private consumption has showed recovery and more resilient against inflation compared with the past. When average propensity to consumer remained flat and real disposable income increases, private consumption will increase in the future.

With wages on the rise and supportive government policies in place, consumer spending in Japan is expected to gradually recover by 2025. However, inflationary pressures are building, making further interest rate hikes all but inevitable. These higher rates are likely to dampen corporate earnings—particularly for major Japanese firms that generate a significant share of their revenue abroad. Nevertheless, steady wage growth and ongoing policy support may help offset some of these headwinds, allowing Japan to move closer to a more balanced “normal” economy despite the challenges.

UK

The UK economy faces complex challenges in 2024. GDP growth in the third quarter of 2024 was just 0.1% quarter-on-quarter, falling short of the 0.2% forecast and highlighting the fragility of the recovery. Although the services sector—accounting for around 80% of GDP—was the main growth driver earlier in the year, it lost momentum in the second half of 2024, reflecting heightened economic uncertainty and eroding confidence.

Fiscal pressures remain a central concern, as the government must balance soaring public debt against the need to foster economic growth. At the same time, shifting global trade dynamics and escalating geopolitical tensions add to external headwinds. While the easing of inflation offers a glimmer of hope, structural issues—such as low productivity and weakened confidence—could limit the impact of any monetary easing measures.

EU

The euro area experienced a rapid decline in inflation, with the headline Harmonized Index of Consumer Prices(HICP) inflation rate falling from a peak of 10.6% in October 2022 to 1.7% in September 2024. The European Commission has forecasted that inflation in the euro area will moderate to 2.4% in 2024, further easing to 2.1% in 2025, and reaching 1.9% by 2026. The main drivers of this decline include easing energy price pressures and reduced demand for food and non-energy industrial goods. However, services inflation has decreased more slowly due to wage pressures and infrequently adjusted prices. The European Central Bank’s monetary tightening since July 2022 has effectively stabilized inflation expectations, limited cost pass-through, and guided inflation toward the target.

On the economic front, growth stagnated between late 2022 and 2023 due to energy shocks and rising interest rates, but the labor market showed resilience. In 2024, the economy recovered with a projected growth rate of 0.8%, while growth disparities among member states have narrowed. Central and Eastern European countries continue to face slightly higher inflation due to higher unit labor costs.

President-elect Trump’s proposed tariffs pose a significant threat to Euro Area growth, with Germany bearing the brunt of the impact. Beyond the direct effects of tariffs, additional growth pressure will stem from rising uncertainty around trade policy—an upward trend already evident in current economic policy uncertainty indicators.

Beyond tariff-related uncertainties, additional factors are exerting downward pressure on economic activity, dampening both investment and consumption. The ongoing Russia-Ukraine conflict, escalating tensions in the Middle East, worsening impacts of climate change, and heightened political uncertainties across parts of Europe are amplifying consumer and investment caution. In response, households are prioritizing financial resilience over discretionary spending, and private investment has remained weak.

Although European natural gas prices have retreated from their peak, they still remain significantly higher than their pre-2022 levels and above those in the United States. This persistent cost gap places a substantial burden on European manufacturers, who are already grappling with elevated energy expenses and heightened competition. Compounding this pressure is China’s increased competitiveness in key manufacturing sectors, which intensifies the challenges faced by European firms. As a result, these combined headwinds pose significant obstacles to industrial recovery across the EU region, especially with Germany.

Political instability in France and Italy should not be overemphasized. Historically, both countries have experienced and weathered frequent episodes of political upheaval over the past 60 years. Although senior leadership may change—through dismissals, resignations, or other shake-ups—mid-level bureaucracies tend to remain stable. From a societal perspective, citizens are accustomed to these cycles of power struggles and leadership turnover. While this undoubtedly hinders policy execution and coherence, its overall impact remains limited.

Europe’s overall market performance is likely to remain lackluster, with only a few standout opportunities among high-quality blue-chip stocks. The economic strength within the EU is clearly divided into three to four tiers. In the current environment, Germany, as part of the top tier, struggles to drive economic growth on its own, while the short-term prospects of other member states remain bleak. Weighed down by structural issues and external pressures, the EU is expected to achieve only low single-digit moderate growth in 2025, with its overall economic performance best described as "tepid."

Conclusion

In our 2025 Global Economic Outlook, we find that both the United States and China are grappling with significant policy and structural hurdles, reinforcing the importance of tracking broader policy directions over rate-cut timelines. Meanwhile, Japan is edging closer to a “normal” economy as wages and prices continue to rise, while the UK’s recovery remains fragile amid persistent fiscal pressures. As for Europe, we anticipate moderate growth in the low single digits in 2025.

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