Economic update - 2025 Review

For AI true believers, 2025 should have been the year that ushered in artificial general intelligence. For Trump true believers, 2025 was the year that Trump saved America, again.

Everyone else was just happy that the AI boom did not crash and that US tariffs did not cause a US and global recession, an escalating trade war, or worse. Meanwhile, Australia proved resilient once again.

“We are now confident we know how to build AGI as we have traditionally understood it.” Sam Altman, OpenAI, CEO, 6 January, 2025.

“Over the past 11 months, we have brought more positive change to Washington than any administration in American history.” President Donald Trump, public address, 18 December, 2025.

What happened in Australia?

The RBA started the year quietly believing it had “landed the plane”: unemployment had remained low during the hiking cycle and inflation was falling towards the RBA’s target band. It had achieved what the UK, Canada, and New Zealand had failed to do (see chart below).

The RBA even felt confident enough to cut interest rates in February, May, and August.

However, it turned out that the plane didn’t want to stop at the end of the runway!

The RBA expected an increase in consumer spending in the second-half of 2025 as falling inflation boosted real incomes, but it did not expect economic growth to grow as strongly as it has in the second half of the year.

“Growth in private demand has strengthened, driven by both consumption and investment. Activity and prices in the housing market are also continuing to pick up.” Statement by the RBA Monetary Policy Board: Monetary Policy Decision, 9 May, 2025.

Just when it seemed aggregate demand was slowing faster than aggregate supply, ‌thus relieving inflationary pressure, demand has picked up again.

Coincidentally, inflation started to grow again in the second half of the year (see chart below). However, the RBA is unsure whether this is an underlying trend or is because of one-off increases across a few categories.

The market now believes the RBA is more likely to raise rates than cut in 2026. Even senior RBA staff members admit uncertainty as to whether the current interest rate is still restrictive.

On the macro level, Australia has held up despite disappointing Chinese growth and the negative impact of US tariffs on global trade and growth.

While not critical economically, Prime Minister Anthony Albanese scored political points by securing a minimal tariff from the US, signing a rare earth deal with the White House, and shoring up US support for the AUKUS nuclear submarine deal. This was in addition to a landslide election win in May. However, policies on AI look thin, and some industry players have lost enthusiasm for green steel initiatives.

Australia has benefited from the rising gold price throughout the year, and a recent rise in copper prices. In contrast, the outlook for iron ore has gone gloomy. Besides lacklustre Chinese economic growth, the giant Simandou iron ore mine in Guinea began operations, and BHP has found recent iron ore price negotiations tough going. Despite this, the price of iron ore remains relatively strong for now. 

What happened around the world?

USA

Donald Trump’s November 2024 presidential election win buoyed the markets as they salivated at the prospect of another four-years of the “Trump put”. Sure, Trump and Peter Navarro were talking up tariffs, but the markets believed that the stock market would keep the administration in line.

But out walked Trump on “Liberation Day” armed with his little placard of “generous retaliatory tariffs”. Markets reeled, mainstream economists decried the move, and major trading partners were in disbelief.

Eight months later and after much bluster and quiet backtracking, the US average tariff rate is a little more than half of the Liberation Day level (see chart below). 

Still, the average effective tariff rate has increased from 2.4% to nearly 17%. Unsurprisingly, inflation and growth have been negatively affected.

Despite this, the US economy has performed better than expected. Many individuals and companies have adjusted and even benefited. Others, particularly the middle and lower classes, have not. Growth and spending have thus taken on a “K-shape”. Inequality could join affordability as a growing concern in 2026.

Despite some high-profile photo opportunities, there are few signs so far of a US manufacturing renaissance. Policy uncertainty and an anti-immigration stance (from Mexican labourers to Silicon Valley founders) has likely cooled the enthusiasm of many potential investors.

“There is a layer of policy uncertainty built on top of an economy that is surprisingly resilient to that uncertainty.” Tracey Alloway, Bloomberg, columnist and podcaster.

With manufacturing and consumers affected by tariffs, the key driver of US growth has been the extraordinary investment in data centres by big tech. S&P estimates that around 80% of the growth in final private demand in the first half of 2025 came from investment in data centres and related tech. Parts of Virginia are literally humming!    

As details of the data centre spending spree emerged, complete with stories of salacious circular funding, the market’s euphoria has turned to doubt - CDS spreads on Oracle have shot up (see chart below). Is AI another dotcom bubble about to burst? Can sky-high share prices be sustained?

For the moment, there is enough good news to keep the hype going. Nvidia earnings keep surprising on the upside, and Google has ended the year strongly on the back of the plaudits for its Gemini 3 model. If the good news dries up, doubts will take over.

Whichever Kevin takes over the Federal Reserve (Hassett or Warsh), he will be hoping that the US labour market does not deteriorate and inflation remains under control, despite upcoming tax cuts and future policy surprises. The world will be hoping that Kevin will be no stooge.

"We're poised for an economic boom, the likes of which the world has never seen. Soon we will host the World Cup and the Olympics, both of which I got. But most importantly, we will celebrate the 250th anniversary of the Declaration of Independence." Donald Trump, public address, 18 December, 2025.

China

Despite various government measures, the Chinese housing sector remains in the doldrums (see chart below). And it looks like it may claim another corporate behemoth with developer China Vanke close to default. 

Source: Bloomberg

The property sector is also dragging down the consumer:

“I drive a ten-year-old car and have no plans to replace it given the economic climate. … If my apartment hadn’t depreciated so significantly, I might have already bought a new one.” Xiao Feng, Beijing Billiard hall owner.

Meanwhile, industrial production and fixed investment have fallen over the year (see chart below).

Source: Bloomberg

With other sectors struggling, China turned to exports to propel growth, and the strategy has succeeded - China is expected to reach its target of 5% growth for 2025.

Trump’s tariffs were a speed bump, but China quickly switched exports to new markets. China also flexed its rare-earth muscles to bargain down the initial tariff levels.

However, from Africa to Europe, increased Chinese exports are already facing some backlash. Can an economy the size of China’s successfully rely on an export-led growth model?

“Continuing to depend on export-led growth risks furthering global trade tensions.” Kristalina Georgieva, IMF, managing director.

The Chinese stock market posted a good recovery during the year, boosted by gains in AI and renewed enthusiasm for its tech stocks. However, as in the US, this mostly benefitted the wealthy.

EU

Despite the German manufacturing sector still struggling with high energy costs and Chinese competition (see chart below), the euro area avoided a recession. More importantly, at 2.1% for the year, inflation appears to be tamed. This has allowed the ECB to cut rates to support the euro area economy.

For Europe, perhaps the biggest concern is geopolitical. For the first time since the end of the Second World War, cracks have appeared in the transatlantic alliance. Further, internal differences have been magnified by the question of Russia and how to help Ukraine.

Japan

The BoJ raised interest rates twice in 2025, in January and December. In between, with inflation consistently above target, BoJ Governor Kazuo Ueda threatened to raise rates. However, he was delayed by a Japanese economy adjusting to Trump’s tariffs, and later in the year, by a new Japanese prime minister.

Now, with a US tariff deal and US exports recovering (see chart below), the BoJ expects the economy to improve next year. The Japanese stock market ended the year strongly, surpassing the close in 1989.

Prime Minister Sanae Takaichi’s USD 117 billion supplementary budget will also boost the economy next year.

Because of the expected improvement in economic growth, high inflation, and increased government borrowing, the market expects the BoJ to raise interest rates further next year. This is reflected in the recent spike in 2-year Japanese Government Bonds (see chart below).

Rate increases will also address recent falls in the yen against the USD. The yen-USD cross rate is politically sensitive locally and in the US.

UK

With the British economy slowing, the BoE cut rates while inflation was falling and then when it was rising. However, as the BoE predicted, after reaching 3.8% in September, inflation is falling again (see chart below).

Meanwhile, the economy continues to show signs of slowing. Unemployment reached 5.1% in the October quarter, the highest level since the COVID-19 pandemic.

This dynamic of stubbornly high inflation and a weakening economy has seen the Monetary Policy Board split 5-4 in its decision in its last four meetings from May to December. Hopefully, as inflation continues to fall next year, the BoE can focus more on supporting the economy.

New Zealand

The RBNZ cut interest rates by 200 bps in 2025 as it responded to a slowing economy. It does not expect the New Zealand economy to recover until the second half of next year.

Final thoughts

2025 has been a chaotic year in terms of economic policy and international relations, with the AI boom (and potential bust) the major distraction. But, the impact of the uncertainty has largely been much less than feared - the bark has been worse than the bite!

However, more uncertainty is a sure bet for 2026, particularly as a new Fed Chair steps in!

The resilience of the Australian economy surprised even the RBA, which now must be vigilant again with inflation. Plenty of external risks loom, but it would be hard to bet against the Australian economy, which went nearly 29 years without a recession‌ until the COVID-19 pandemic.