Though it has fallen well below its pandemic-era peaks, the nominal pace of U.S. wage growth remains strong, at about 4%. Yet wage growth does not appear to be an impediment to inflation returning to the Federal Reserve’s 2% target. That’s because productivity gains have risen toward historical highs, also around 4%.

In the U.S., productivity trend supports 4% wage growth

^{Notes: Data are charted quarterly and reflect year-over-year changes. The line showing trend productivity growth assumes 2% inflation.}

^{Sources: based on data from the Federal Reserve Bank of St. Louis FRED database through September 30, 2024.}

If productivity were to fall back to post-global-financial-crisis averages, Adam Schickling, a Vanguard senior economist, said wage growth would have to come down closer to 3% to remain noninflationary.

Productivity is notoriously difficult to predict. Restrictions in labor supply and trade could impede it. However, productivity is driven most by the application of technology to work. Vanguard’s global chief economist, Joe Davis, is cautiously optimistic about the potential for artifical intelligence to boost productivity growth and improve living standards, offsetting the headwind of an aging population.

Outlook for financial markets

We have forecasts for the performance of major asset classes, based on the 31 December, 2024, running of the Vanguard Capital Markets Model®. Equity returns reflect a range of 2 percentage points around the 50th percentile of the distribution of probable outcomes. Fixed income returns reflect a 1-point range around the 50th percentile. More extreme returns are possible.

Australian dollar investors

Australian equities: 4.5%–6.5% (21.8% median volatility)

Global equities ex-Australia (unhedged): 4.1%–6.1% (18.8%)

Australian aggregate bonds: 4.1%–5.1% (5.6%)

Global bonds ex-Australia (hedged): 4.4%–5.4% (5.0%)

^{Notes: These probabilistic return assumptions depend on current market conditions and, as such, may change over time.}

^{Source: Vanguard Investment Strategy Group.}

^{IMPORTANT: The projections or other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modelled asset class. Simulations are as of 31 December, 2024. Results from the model may vary with each use and over time.}

Region-by-region outlook

The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of 20 February, 2025.

Australia

On February 18, the Reserve Bank of Australia (RBA) cut interest rates for the first time in more than four years, reducing its policy cash rate target by 0.25 percentage point to 4.1%. Despite this move, the RBA is expected to proceed cautiously with further cuts due to sticky services inflation and a tight labor market.

We expect:

The central bank to trim its cash rate target to 3.5% by year-end.
Economic growth of about 2% for full-year 2025, with support from rising real (inflation-adjusted) household incomes, a rebounding housing market, and rate-cut expectations.
The annual pace of trimmed mean inflation, which excludes items at the extremes, to fall to the midpoint of the RBA’s 2%–3% target range late this year. It registered 3.2% in the fourth quarter of 2024.
The unemployment rate to rise to about 4.6% this year, up from 4.1% in January, as financial conditions tighten.

United States

Federal Reserve policymakers left their target for short-term interest rates unchanged, in a range of 4.25%–4.5%, in their first meeting of 2025. We expect they will continue to bide their time.

We further expect:

The Federal Reserve to cut rates twice in the second half of the year—a deferral from our previous forecast of rate cuts in the first half, reflecting the recent strength in labor and inflation reports.
2025 economic growth of 2.1%, reflecting assumed changes in trade and immigration policies.
The unemployment rate to rise marginally in 2025, to the mid-4% range. If labor supply constraints exceed our base-case assumptions, however, unemployment may fall and both wage growth and inflation may climb.

Inflation to remain in focus. A University of Michigan survey this month indicated that consumers expect 4.3% inflation over the next year, up a full percentage point from January. It isn’t clear whether the readings reflect a signal or noise amid policy uncertainty.

Canada

Recent economic conditions in Canada have been mixed. Growth has slowed and inflation has moderated, despite strength in the labor market.

We expect:

Economic growth of less than 2% in 2025, despite more accommodative monetary policy. Parliamentary elections late this year and interactions with the new U.S. administration bear watching.
The core rate of inflation to register 2.1%–2.4% this year, just above the midpoint of the Bank of Canada’s 1%–3% target.
The unemployment rate to remain this year around current levels—it stood at 6.6% in January—with much depending on trade uncertainty and immigration developments.
The Bank of Canada to cut its target for short-term interest rates at a more cautious pace this year, given the tariff uncertainty and its negative impact on growth and upside risk to inflation.

Euro area

A weak growth outlook and benign inflation likely will encourage the European Central Bank (ECB) to be relatively dovish in 2025. With Germany’s elections having taken place on 23 February and the potential for peace negotiations over Ukraine, uncertainty is high.

We expect:

The ECB to cut its policy rate by 0.25 percentage point at each meeting until the July meeting, and then hold it at 1.75%. The current rate is 2.75%.
Below-trend economic growth around 0.5% for 2025, with continued malaise in the manufacturing sector likely to weigh on final demand.
The headline and core rates of inflation to both end 2025 below 2%.
The unemployment rate to rise toward 7% by the end of 2025. It stood at 6.3% in December.

United Kingdom

Recent economic conditions in the United Kingdom have shown signs of stagflation, with the economy experiencing minimal growth and rising inflation.

We expect:

Quarterly interest rate cuts by the Bank of England that would leave the bank rate at 3.75% at year-end, down from 4.5% today.
2025 economic growth of 0.7%, down from our previous forecast of 1.4%, reflecting in part a deterioration in forward-looking data, particularly on the labor market.
Headline inflation to end 2025 at 2.5% and core inflation, which excludes volatile food, energy, alcohol, and tobacco prices, to end the year at 2.7%, both on a year-over-year basis. Both forecasts are 0.3 percentage point higher than our previous estimates.

The unemployment rate to rise to 4.7% by year-end, up from 4.4% in the October-through-December 2024 period.

Japan

The Bank of Japan resumed its rate-hiking cycle in January. A stronger-than-expected GDP reading amid continued demand for exports supports our view for further interest rate hikes.

We expect:

The Bank of Japan to gradually increase its policy rate to 1% by year-end, up from 0.5% today. We believe rate adjustments are intended to align monetary policy with a normalized inflation regime, not as a bid to curtail demand in response to rising inflation.
2025 economic growth to be above trend at about 1.2%, driven by a pickup in domestic demand as wage gains outpace inflation.
Core inflation to remain robust at about 2% in 2025.
A structural supply shortage in the labor market to continue exerting upward pressure on wages.

China

Investor sentiment in China is improving, bolstered by the emergence of AI start-up DeepSeek and a 24% rise in the Shanghai Composite Index from a September 2024 low. President Xi Jinping's meeting with prominent entrepreneurs on February 17 underscores the growing importance of the private sector.

We expect:

Increased fiscal stimulus, including a one-off overshoot of the debt ceiling to address local government debt and excess housing supply. Monetary easing will support fiscal expansion.
Near-term momentum in economic growth, as policy support takes effect. Real (inflation-adjusted) growth likely will slow to about 4.5% this year due to trade tariffs.
The rate of core inflation to be about 1.5% this year, thanks mainly to currency depreciation in the face of higher tariffs. Otherwise, deflationary pressures remain. Producer prices were down 2.3% year over year in January, a 28th consecutive month of decline.
The unemployment rate to remain this year around its current (5.1% in December) level. Structural mismatches in labor supply and demand, especially among younger workers, may persist.

Emerging markets

We expect the monetary policy easing cycle to broaden, albeit with rates remaining in restrictive territory as a strong U.S. dollar threatens to stoke emerging markets inflation. Trade developments are likely to be in focus throughout 2025.

In Mexico, we expect:

A central bank easing cycle that began in March 2024, when the policy rate was 11.25%, to continue. We forecast that the overnight interbank rate will end 2025 in a range of 8%–8.25%, down from 9.5% today.
The core rate of inflation, which excludes volatile food and energy prices, to fall to 3.25%–3.5% in 2025, above the midpoint of Banxico’s 2%–4% target range.
Economic growth of 1.25%–1.75% this year, with potential for further slowing if trade tensions escalate.

^{Notes: All investing is subject to risk, including the possible loss of the money you invest.}

^{Investments in bonds are subject to interest rate, credit, and inflation risk.}

^{Investments in stocks and bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.}

^{IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.}

^{The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.}

^{The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.}

^{This article contains certain 'forward looking' statements. Forward looking statements, opinions and estimates provided in this article are based on assumptions and contingencies which are subject to change without notice, as are statements about market and industry trends, which are based on interpretations of current market conditions. Forward-looking statements including projections, indications or guidance on future earnings or financial position and estimates are provided as a general guide only and should not be relied upon as an indication or guarantee of future performance. There can be no assurance that actual outcomes will not differ materially from these statements. To the full extent permitted by law, Vanguard Investments Australia Ltd (ABN 72 072 881 086 AFSL 227263) and its directors, officers, employees, advisers, agents and intermediaries disclaim any obligation or undertaking to release any updates or revisions to the information to reflect any change in expectations or assumptions.}