A Green Dilemma for Monetary Policy

Economic

Summary:

Accelerating the transition to a green economy is a necessity.

This column argues that the green transition will create trade-offs for central banks. Phasing out polluting technologies is likely to temporarily slow down productivity growth, thus creating inflationary pressures. If central banks choose to ‘look through’ and let inflation temporarily rise, inflation expectations may de-anchor. A tight monetary policy approach, instead, will lead to unemployment, lower investments in green technologies, and potentially permanent damages to GDP and the green transition. Fiscal and credit policies that sustain green investments may be the best option to address these trade-offs.

It is a shared understanding that accelerating the transition towards a green economy is imperative (Bilal and Kanzig 2024). What are the challenges that central banks are going to face during the green transition? In a recent report written for the Bank of International Settlements (Fornaro et al. 2024), we propose a framework to address this question.

Our starting point, as argued by Jean Pisani-Ferry and Selma Mahfouz (Pisani-Ferry and Mahfouz 2023), is that the transition will involve a structural transformation of our economies away from polluting technologies and towards clean ones. Green regulations, by constraining the use of polluting technologies, will trigger a rise in the price of dirty goods relative to clean ones. Lower access to polluting technologies will slow down productivity growth, unless green technologies are developed and adopted sufficiently fast. As we argue, these forces will confront central banks with a ‘green dilemma’.

The inflationary consequences of the green transition

We consider an economy in which production is carried out using two types of intermediate goods: clean and dirty. Clean goods are produced using non-polluting technologies, while production of dirty goods degrades the quality of the environment. As in the New Keynesian tradition, monetary policy has real effects because of nominal (wage) rigidities.

We model the green transition as a gradual tightening of a production cap, or supply constraint, on dirty goods. This constraint may represent a limit on carbon emissions imposed by green regulations, such as the emission caps imposed by the EU Emissions Trading System, or even carbon tax policies designed to hit some emissions reduction target. The underlying assumption is that the regulator internalises the long-term costs of climate change, although we do not model them explicitly.

When the supply of dirty goods is constrained by regulation, their relative price increases, inducing a desirable reallocation of production towards clean goods. However, the rise in the relative price of dirty goods is a source of inflationary pressures (see also Del Negro et al. 2023).

More precisely, supply constraints on dirty goods give rise to a non-linear aggregate Phillips curve: relatively flat when employment is low enough so that supply constraints on dirty goods are slack, and steep when employment exceeds the threshold that makes supply constraints bind (Figure 1). In the latter case, an increase in employment not only leads to the standard rise in nominal wage growth, but also to an increase in the relative price of dirty goods. As green regulations become tighter, supply constraints on dirty goods start binding at lower levels of employment. As a result, a larger portion of the Phillips curve becomes steeper.

This observation carries two important implications. First, during the green transition central banks are going to face a worse trade-off between inflation and employment. Second, business cycle fluctuations driven by demand shock may give rise to high inflation volatility. Intuitively, periods of high aggregate demand are associated with binding supply constraints on dirty goods, causing sharp rises in their relative price and in overall inflation. When aggregate demand is low, instead, supply constraints on dirty goods are slack, inflation falls somehow, but not enough to compensate for the rise in inflation during demand-driven booms.

Endogenous technological change during the green transition

The development and adoption of green technologies has the potential to reconcile carbon emissions reductions and healthy productivity growth (Hemous et al. 2009). To take this effect into account, we introduce endogenous technological change in polluting and green technologies. Tighter supply constraints on dirty goods now also foster a reallocation of investment towards green technologies, mitigating the productivity losses due to the phasing out of polluting goods. The strength of this force, however, is partly determined by the monetary policy stance.

As it is intuitive, in our model a monetary contraction depresses investment. But, more interestingly, we show that this effect is stronger for green technologies. This is due to two effects. First, monetary policy affects investment through its impact on interest rates and the cost of capital. However, due to the progressive tightening of green regulations, firms producing dirty goods have a short time horizon ahead. Hence, their investment decisions are not that sensitive to changes in interest rates.

Second, monetary policy affects investment by determining aggregate demand and firms' profits. For instance, a monetary expansion stimulates investment because the associated increase in aggregate demand makes it more profitable for firms to build up their productive capacity. But healthy aggregate demand favours particularly green investments, because environmental regulation prevents dirty firms from expanding. This creates an additional trade-off for central banks. A narrow focus on maintaining inflation at target in the short term may discourage green investments and impair productivity over a longer horizon, which implies higher inflation later.

We provide some novel empirical evidence in support of this effect, by studying how investments by green firms react to monetary policy shocks. For instance, Figure 2 shows that an unexpected monetary contraction has a particularly negative impact on R&D investments by green firms. Our results are in line with the practitioners’ view that monetary and financial factors are particularly salient for green investments (Martin et al. 2024), as well as with recent evidence by Aghion et al. (2024), who show that investments in green technologies by German automotive firms are especially sensitive to monetary shocks.

This empirical evidence suggests that it is important to consider the impact of monetary policy on green investments.

A green dilemma for central banks

We are now ready to use our framework to consider the dilemma that central banks will face during the green transition. Figure 3 shows a simulated path of the green transition under different policy configurations.

One option is to ‘look through’ the inflationary shock triggered by the phasing out of dirty technologies (blue lines). The benefit of this approach is that a temporary rise in inflation speeds up the rise in the relative price of dirty goods needed to phase out dirty technologies. Moreover, a ‘look through’ approach guarantees high employment during the transition. But, even though we don’t model this explicitly, there is a risk that high inflation may induce a de-anchoring of inflation expectations.

A second possibility is to implement a tight monetary policy, suppressing the inflationary impulse coming from the green transition (red lines). The problem with this strategy is that maintaining inflation on target requires high economic slack and substantial unemployment. Moreover, a tight monetary policy approach will discourage green investments. On the one hand, this will lead to permanent productivity and GDP losses. On the other hand, this will slow down the transition towards a clean economy.

The role of green fiscal and credit policies

As we have seen, the green transition may represent a significant challenge for central banks. But coordination between monetary, fiscal, and credit policies may be the key to a smooth transition, reconciling the greening of our economies with high economic activity and low inflation. We argue that fiscal subsidies and target credit policies supporting green investments may play a crucial role.

This policy mix is illustrated by the green lines in Figure 3. There we assume that monetary policy is sufficiently tight to maintain inflation on target during the transition, but fiscal subsidies and targeted credit policies insulate green investments from the negative impact of monetary contractions.

There are two results worth highlighting. First, subsidising green investments reconciles low inflation with a swift green transition. Second, the output losses needed to maintain inflation on target are now much smaller and transitory. This happens because the pro-green fiscal and credit policies undo the negative impact of monetary contractions on productivity and output over the medium run. In addition, fast productivity growth in the green sector acts as a disinflationary force, reducing the need for the central bank to implement a tight monetary policy to maintain inflation on target.

In sum, policy interventions fostering green investments may not only be useful because they reconcile phasing out polluting technologies with healthy productivity growth. They can also fulfil a useful macroeconomic stabilisation role and complement traditional monetary policy to guarantee high economic activity and low inflation during the green transition.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Goldman Sachs

Economic

Stocks

The benchmark index of US equities is projected to rise to 6,500 by the end of 2025, a 9% price gain from its current level and a 10% total return including dividends, David Kostin, chief US equity strategist at Goldman Sachs, writes in the team’s report. Earnings are predicted to increase 11% in 2025 and 7% in 2026.

What’s the outlook for the S&P 500 in 2025?

Corporate revenue growth (at the index level) typically moves in line with nominal GDP growth, according to Goldman Sachs Research. Our strategists’ estimate of 5% sales growth for the S&P 500 is consistent with our economists’ forecasts for 2.5% real GDP growth and for inflation to cool to 2.4% by the end of next year.

The incoming administration of President-elect Donald Trump is expected to introduce trade policy that includes targeted tariffs on imported automobiles and select imports from China while also cutting taxes. “The impact of these policy changes on our earnings-per-share forecasts roughly offset one another,” Kostin writes.

Goldman Sachs Research’s S&P 500 EPS forecasts for 2025 and 2026 are $268 and $288, in line with the median top-down consensus estimates of $268 and $288. However, these are below the bottom-up consensus (based on individual company earnings estimates made by equity analysts) of $274 and $308.

The S&P 500 is Forecast to Return 10% in 2025_1

At the same time, valuations are high by historical standards and may be a risk for investors. The P/E multiple of the S&P 500 index has increased by 25% during the past two years. Today, the P/E multiple equals 21.7x and ranks at the 93rd historical percentile. At the end of 2022, the index traded at a multiple of 17x.

What are the main risks to US stocks next year?

“An equity market that is already pricing an optimistic macro backdrop and carrying high valuations creates risks heading into 2025,” Kostin writes. High multiples are weak signals for near-term returns, but typically increase the magnitude of market downturns when there’s a negative shock, he writes.

According to Goldman Sachs Research’s baseline macroeconomic outlook, the economy and earnings continue to grow and bond yields remain around current levels in the coming years. But there are a number of risks heading into 2025, including the potential threat of an across-the-board tariff and the potential of higher bond yields. At the other end of the spectrum, a friendlier mix of fiscal policy or more dovish policy from the Federal Reserve could result in higher returns.

“As a result, we believe investors should take advantage of periods of low volatility to capture equity upside or hedge downside through options,” Kostin writes.

What’s the outlook for the Magnificent 7?

The Magnificent 7 tech stocks are expected to continue to outperform the rest of the index next year — but by only about 7 percentage points, the slimmest such margin in seven years.

The superior earnings growth of the Magnificent 7 has driven the collective outperformance of these stocks compared with the balance of the S&P 500 index. But consensus expectations predict the gap in earnings growth between the Magnificent 7 and the S&P 493 will narrow from an estimated 30 percentage points this year, to 6 percentage points in 2025, and to 4 percentage points in 2026.

The S&P 500 is Forecast to Return 10% in 2025_2

Although earnings continue to weigh in favor of the Magnificent 7, macro factors such as growth and trade policy lean towards the S&P 493. Our economists’ expectation of a steady and above-trend pace of US growth in 2025 favors the performance of the S&P 493, which is more sensitive to changes in growth compared with the Magnificent 7.

Trade policy risk also favors the S&P 493, which has a greater share of earnings derived domestically relative to the Magnificent 7. Our economists note that trade friction represents an important risk for their baseline forecast. In particular, more restrictive US trade policy would likely affect non-US growth more acutely compared with US growth. The Magnificent 7 derive nearly half of their sales from outside the US compared with 26% for the S&P 493.

Mid-cap stocks could be an opportunity for investors, Kostin writes. The S&P 400 has a long track record of outperformance versus large- and small-cap stocks, similar consensus earnings growth as large-caps, and trades at a lower absolute P/E multiple (16x).

What is the outlook for M&A?

As the US economy and corporate earnings grow, and as financial conditions become relatively looser, our analysts expect increased M&A activity in 2025. Renewed merger activity should be aided by the potential for less regulation in certain industries during the incoming Republican administration.

The S&P 500 is Forecast to Return 10% in 2025_3

Goldman Sachs Research forecasts approximately 750 completed US M&A transactions above $100 million in 2025, a 25% year-on-year increase from 2024. Firms are likely to boost cash M&A spending by 20% to $325 billion in the coming year. Total merger volume should increase by an even greater amount because elevated stock valuations make share consideration an attractive alternative to cash,” Kostin writes

Where does AI investment go next?

Investor views on the impact of AI continue to vary widely, Kostin writes, with some market participants believing in the transformative power of generative AI and others skeptical that companies can generate attractive returns on their high AI investment.

In 2025, our analysts expect investor interest in AI to transition from AI infrastructure to a broader AI "Phase 3" of application rollout and monetization. This phase refers to companies that are likely to see AI-enabled revenues, beyond those that build the infrastructure underlying AI.

These phase 3 companies include software and services firms, which offer investors longer-lasting, secular growth, and which are relatively less reliant on changes in economic expansion or interest rates to drive share prices.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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Pepperstone

Economic

Forex

This uncertainty has the potential to impact the region’s export sector in various ways, while the slowdown in global economic growth outside the United States will likely continue weighing on Latin American economies. In this context, capital flows to the region could be dampened in the coming calendar year, and with a more volatile external environment, a substantial recovery for LATAM currencies seems challenging for 2025.

This outlook examines the prospects for the Mexican peso (MXN), Colombian peso (COP), and Chilean peso (CLP).

MXN

Relative Protection from the USMCA, Despite Uncertainty

The Mexican peso faces an uncertain landscape in 2025, primarily due to trade policies that the Trump administration could implement. While the United States-Mexico-Canada Agreement (USMCA) should provide some protection against a more restrictive global trade environment, recent statements by President-elect Donald Trump, including potential tariff increases of up to 25% for Mexico and Canada, pose a significant risk to Mexico’s economy. Although the treaty is not formally scheduled for review until 2026, the process could generate additional tensions in trade relations between Mexico and the United States. For now, expected modifications are likely to focus on limiting imports of products from China, particularly in key sectors such as automotive and electronics.

In the short term, political headlines could suppress appetite for the MXN. However, the USMCA is likely to remain in place, which could provide eventual relief for the peso. Negotiations may also focus on ensuring that local reforms, such as judicial ones, do not breach the agreement. It is worth noting that while the United States may adopt a more nationalist stance, it is unlikely to completely close its doors to trade. Mexico should remain an important ally as the U.S. continues to compete with the Asian giant, China.

In terms of monetary policy, the Bank of Mexico (Banxico) is expected to proceed cautiously with its easing cycle, with a terminal rate anticipated at 9% from the current 10.25%. This could limit the depreciation of the peso against the dollar, but uncertainty surrounding Trump’s trade and immigration policies will keep volatility high.

COP

Vulnerable to External Factors and Weak Fundamentals

The Colombian peso is in a particularly vulnerable position in 2025, due to a combination of external and internal factors affecting its performance. External uncertainties, such as weakened global growth outside the United States and expected lower oil prices (with an average of $75 per barrel in 2025 versus $80 in 2024), could weigh on Colombia’s finances. This scenario is exacerbated by internal fiscal risks, such as the difficulty of reducing the fiscal deficit to pre-pandemic levels of 3% of GDP. Estimates suggest the fiscal deficit for 2024 and 2025 will remain above 5% of GDP, with debt-to-GDP ratios exceeding 60%.

Low tax revenues and attempts to modify the fiscal rule are key concerns for investors. These factors position the COP as one of the most vulnerable currencies in the region.

CLP

China's Slowdown

The Chilean peso faces a relatively different scenario in 2025, where slower growth in China could act as a negative factor for the country. However, increased stockpiling of raw materials could help support commodity prices. China has intensified its focus on stockpiling commodities and strengthening trade with nations such as Chile, which could help prevent a significant decline in Chilean exports. It is important to note that China is Chile's main trading partner, demanding large quantities of one of Chile’s key resources: copper, with over half of copper exports directed to the Asian giant.

However, a key vulnerability for the CLP is the increasingly narrow rate differential with the U.S., amid a context of "American exceptionalism" and persistent inflation in the United States. The Central Bank of Chile is expected to lower rates from the current 5.25% to 4.5% in 2025, which could make the CLP less attractive internationally.

Conclusion

A Complex Environment for LATAM FX in 2025

The outlook for Latin American currencies in 2025 is complex, marked by political and economic uncertainty. Donald Trump’s return to the White House introduces a significant degree of uncertainty, particularly around trade policies that could impact the export sectors of Mexico, Colombia, and Chile in various ways. While the USMCA may offer some protection for the MXN, the COP and CLP face significant risks due to weak internal fundamentals and slowing global growth.

In summary, investors should prepare for a challenging and volatile environment in 2025, remaining alert to policy changes and economic signals at both national and global levels. Each country’s ability to adapt to these challenges will be crucial to the performance of its respective currency in what promises to be one of the most complicated years for LATAM FX in recent times.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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ING

Energy

Economic

What's hindering the green transition in Germany's housing market?

The buildings sector has enormous potential to contribute to the German economy's green transition; after all, it accounts for some 30% of total greenhouse gas emissions. However, the path to 'greener living' has been anything but smooth. The last few years have been characterised by elevated policy uncertainty, with new rules, withdrawn rules, new subsidies, withdrawn subsidies.... you get the picture. And this back-and-forth is seriously not helping.

But uncertainty isn't the main barrier preventing an acceleration in the housing market's green transition. Financing and the willingness to financially contribute to the green transition are. At least that's according to the results of the latest ING consumer survey.

Two-thirds of the homeowners surveyed stated they'd taken measures to increase their home's energy efficiency in the past three years. However, most of these were related to reducing the energy consumption of their devices. Less than 50% of respondents carried out actual measures on the building, such as installing a new heating system or improving thermal insulation.

At the same time, a third of respondents had not taken any energy efficiency-improving measures in the past three years. According to the survey, financing costs are too high, and government support programmes are insufficient. More than a third of those who had not taken any green renovation measures in the past three years said that this was due to financial difficulties.

What prevented you from increasing the energy efficiency of your property?

Homeowners who'd stated they'd not carried out measures to increase the energy efficiency of their property in the past three years.

The top 3 answers

Carrot And Stick: The Key To Germany’s Green Housing Transition_1

Source: ING Consumer Research

In fact, the green transition on the German housing market comes at a price. A back-of-the-envelope estimate yields an average cost of 350 billion to 1 trillion euros at current prices to achieve the required energy savings, depending on whether the energy savings are reached via deep renovations or smaller-scale measures. Thus, the average cost of a green renovation would range between 25,000 and 76,000 euros per home.

The green transition is still an uphill battle

So, it doesn't come as a surprise that the results of our latest ING consumer survey indicate that the green transition in the housing market will prove to be an uphill battle unless more financial support is provided. A quarter of those respondents who have not yet taken any measures to improve their homes' energy efficiency would only consider doing so in the future if the renovation costs were fully or at least partially covered by subsidies or tax relief.

A further 30%, however, would only take energy efficiency-improving measures under coercion. Neither energy cost savings nor financial support would suffice as an incentive for green renovations. The findings of our ING consumer survey thus suggest that, in addition to financial support, clear government guidelines are needed for the green transition in the housing market to gain momentum.

Would you consider taking energy-efficient measures under certain circumstances?

With regard to measures to increase the energy efficiency of their home, respondents were asked what their minimum requirement would be.

Carrot And Stick: The Key To Germany’s Green Housing Transition_2

Source: ING Consumer Research

The European Commission has cracked the whip, but who's listening?

Interestingly, we are getting a clear message here. While the European Commission abandoned its goal of making all homes in the EU carry at least an energy label of D by 2033, it adopted the revised EU Energy Performance of Buildings Directive (EPBD) in April this year. This regulation requires that the average energy consumption of the entire housing stock should be reduced by 16% - compared to 2020 - by 2030. The European Commission also set out that 55% of primary energy savings should be achieved by renovating the 43% most energy-inefficient homes.

Government pressure to renovate is already here, at least in theory. In practice, it will probably still take until 2026 before the EU legislation is implemented into national law.

The green transition - or the lack of it - is making its mark

While a clear regulatory direction is still pending, the green transition, or the lack thereof, is already leaving clear marks in the housing market, and this impact could even intensify as regulation progresses. One in two respondents surveyed in our latest ING consumer survey expects the affordability of buying energy-efficient housing to deteriorate as a result of upcoming stricter regulations.

Over the past few years, the price gap between energy-efficient homes and their energy-inefficient counterparts has already widened substantially. However, given that financing and construction costs remain elevated, it might very well be that any savings resulting from buying a less energy-efficient home will be fully absorbed by high renovation costs.

Deviation in property costs per energy efficiency class

From energy efficiency class A+

*as of October 2024

Source: ING

On the other hand, the price premium paid for energy-efficient homes has increased significantly. Investing in an already renovated property or an energy-efficient new build instead of renovating an existing home may save the potentially high renovation costs, but a premium for the property's 'G-Factor', the degree of greenness of a home, will eventually be demanded. Looking ahead, this price premium could increase even further as regulation tightens.

Carrot and stick will be key for a successful green transition

The green transition of the German housing market will only gain momentum when the crack of the EU Commission's whip is heard clearly across Germany. However, simply mandating green renovations will not be enough. With financial issues and a lack of willingness to financially contribute being the main obstacles to a successful green transition of the housing market, those who push must also promote.

For the green transition to succeed, it needs both the carrot to reduce the barriers to green investments and the stick to get that investment activity actually moving at pace.

To stay updated on all economic events of today, please check out our Economic calendar

Risk Warnings and Disclaimers

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SAXO

Economic

Bond

The fixed-income world is poised for significant shifts as Scott Bessent prepares to take the reins at the U.S. Treasury. His tenure promises to combine strategic financial expertise with a practical understanding of fiscal realities, signaling both innovation and a steady hand in managing America’s debt. For investors, the implications are profound, particularly as they brace for continued high Treasury issuance and a bold approach to managing long-term borrowing costs.

Ultra-Long Bonds: A Bold Bet on Stability

Perhaps the most intriguing part of Bessent’s vision is his openness to issuing ultra-long Treasury bonds—securities with maturities of 50 years or even 100 years. This isn’t just a technical adjustment; it’s a statement. Ultra-long bonds send a clear signal about how the Treasury plans to manage its debt in a changing economic environment.

Why now? The rationale is straightforward. If Bessent believed interest rates were heading lower, the logical move would be to stick with short-term debt and refinance and extend duration later at cheaper rates. Instead, his focus on ultra-long bonds suggests a belief that rates are likely to stay where they are—or even rise.

Other countries, like Mexico and Austria, successfully issued ultra-long bonds when interest rates were far lower, showing there’s market appetite for such securities. Bessent appears confident that investors—particularly those looking for secure, long-duration assets—will step up. For fixed-income managers, this creates a new landscape of opportunities and challenges. Ultra-long bonds steepen the yield curve and introduce new dynamics into portfolio management, especially for those balancing duration against inflation risks.

The Bigger Picture: Growth, Deficits, and Global Stability

Bessent’s tenure will also be defined by his approach to fiscal discipline. Proposed spending cuts aim to chip away at the deficit, but these measures face political and practical hurdles. Meanwhile, growth-oriented policies, including tax cuts, tariffs and infrastructure investment, could stoke inflationary pressures, complicating the fixed-income outlook.

At the same time, Bessent is steadfast in his commitment to preserving the U.S. dollar’s role as the world’s reserve currency. If Bessent and the Trump administration follow through on that commitment, it would ensure continued international demand for Treasuries, even as issuance remains high. For foreign investors, Treasuries remain a critical store of value with no real alternative, but alternatives might be sought if US policy is seen as engineering negative real interest rates or financial repression.

What This Means for Investors

Scott Bessent’s approach to managing U.S. debt brings both opportunities and challenges for fixed-income investors. Here's how to navigate the changes:

1. Rethink Long-Term Investments:

Ultra-long bonds (like 50-year or 100-year Treasuries) may become more common. These bonds offer higher interest rates, which can be appealing if you’re looking for stable, very long-term income. However, they also come with risks:

Inflation Risk: Over time, inflation could erode the value of your fixed interest payments.

Interest Rate Risk: These bonds are more sensitive to changes in interest rates, meaning their prices can drop sharply if rates rise.

Tip: Consider ultra-long bonds only if you’re confident in your long-term financial outlook and can handle potential price swings.

2. Keep an Eye on Inflation:

Policies promoting economic growth, such as tariffs or infrastructure spending, could lead to higher inflation. When inflation rises, the purchasing power of bond returns decreases, especially for longer-term bonds.

Tip: Look for bonds that adjust for inflation, like Treasury Inflation-Protected Securities (TIPS), to protect your investment.

3. Be Ready for Market Shifts:

The Treasury plans to issue more bonds across all maturities, which could lead to changes in the bond market. For example, as the government issues more long-term bonds, yields may rise, making short-term bonds less attractive.

Tip: Stay flexible and diversify your bond investments across different maturities to manage risks and take advantage of opportunities as the market evolves.

To stay updated on all economic events of today, please check out our Economic calendar

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Brookings Institution

Economic

Leapfrogging into the 4IR

Despite Africa’s slower rates of internet penetration compared to the rest of the world, it is leading the way in other key areas of digitalization, including in the financial industry, indicating that there may be important leapfrogging opportunities available.

Africa is home to more than half of the world’s registered and active mobile money accounts (800 million), and in 2023 sub-Saharan Africa was home to almost three-quarters of the world’s accounts and was the source of 70% of the growth in registered accounts. This uptick is in part due to the successful increase in mobile phone subscriber penetration, which outpaces broadband expansion and reached 43% in 2023, with mobile phones accounting for three-fourths of total online traffic in Africa. Mobile money increased GDP in the region by more than $150 billion between 2012-2022 (3.7%). This has led to a robust fintech sector on the continent with lucrative opportunities for the future—according to McKinsey, fintech is expected to reach $400 billion globally by 2028.

A key leapfrogging opportunity lies in digital banking and payments. Approximately 90% of all financial transactions in Africa are conducted using cash and coins. Only 2% of Senegal’s population, for example, used a debit card as of 2022, and reliance on cash remains strong meaning there is great opportunity for these countries to leapfrog directly to digital payments.

The impact of advanced technologies

To facilitate such leapfrogging, advanced technologies are leading the way, with ample African-led innovations entering the financial services market.

AI tools are helping customize financial services, from tracking financial transactions to investments and lending. These tools can help personalize services for customers in Africa and thus bring more people into financial services. The size of Africa’s population and number of interactions with digital financial services gives the continent an edge over other regions, since the high volume of data can help train new and existing algorithms faster, according to Sehrish Alikhan of Finextra.

Blockchain, which increases the transparency and security of financial transactions, is helping power cross-border payments and decentralized lending. It also dramatically cuts the costs of digital financial transactions and builds trust, which is critical for African fintech.

IoT is also at work in the financial sector. For example, M-KOPA, a Kenyan digital financial services company, has integrated advanced IoT technologies into its digital micropayments service, improving processing speed to 500 payments per minute and reaching 3 million people across the continent. The company uses Microsoft’s AI services to forecast and manage financial risk, allowing it to reach millions of unbanked and underbanked Africans and provide them with loans for purchases such as solar lighting, smartphones, refrigerators, and more.

New areas for growth and outlooks

African-led companies are also expanding into new areas of financial services, recognizing ripe opportunities to use advanced technologies in novel ways.

Regulation technology or “regtech” is the use of advanced technologies to design new regulatory tools and enhance regulatory processes, including using AI to monitor data for regulatory data, using blockchain to track and verify compliance data, and using natural-language processing to help organizations understand regulatory requirements. RegTech is becoming an area of interest on the continent and in Nigeria, for example, is expected to see a 40% increase by 2026.

Cryptocurrencies are also increasing in popularity in some parts of the continent. In 2023, Nigeria was ranked #2 in the Global Crypto Adoption List, behind India and ahead of the United States. The continent is even leveraging AI to create a new digital currency—the LUMI A.I. Commemorative Coin. One LUMI is backed by 100kWH of solar energy—equivalent to 4 grains of gold—and has gained increasing legitimacy, especially as digital economy platforms such as Swiffin/HanyPay have started to use it. AI is embedded in the currency’s digital coin, making transactions more efficient and secure through advanced encryption methods and allowing it to be integrated into digital platforms including mobile wallets and online banking systems.

Fully digital banks, or neobanks, are also starting to emerge as potential players in the industry. South Africa’s TymeBank made its first monthly profit (a challenging mark for neobanks to reach) in December 2023, according to African Business, signaling that it could become more of a player in the years to come.

Challenges and strategies

These innovations within the financial services sector are showing local and global investors that advanced technologies will continue to change the game in the African market. Despite impressive progress, challenges remain. Millions remain unbanked across Africa, in particular women, according to Leora Klapper at Brookings, which means significant efforts must be made to ensure full financial inclusion.

Although a number of strategies will be required to overcome these challenges, three are of particular importance.

First, African countries must provide an agile regulatory environment that both enables innovation and protects citizens. The approach will likely differ in each country based on its unique context. For example, as research from the Carnegie Endowment for International Peace explains, Kenya has used a “test and learn” approach which helped M-PESA, Kenya’s successful mobile money service, pilot and scale. Nigeria, in contrast, for the most part follows a “banking-led model,” and the Central Bank of Nigeria has played a leading role in prohibiting and approving mobile network operators from operating within mobile money services. Zimbabwe, meanwhile, has found success using fintech regulatory sandboxes, which provide companies with an experimental approach to better understand how regulations may affect them. The speed and scale at which advanced technologies are being developed and deployed across industries makes it necessary for African countries to move away from old methods of regulation that are often more reactive than proactive. To do so, countries should look at the experience of their African counterparts and think strategically about how their unique business dynamics and overall context might best be supported by different and more agile forms of regulatory environments.

Second, African countries should better integrate advanced technologies to improve regulatory environments. RegTech offers tools for countries to experiment with a new way of thinking about regulation—one that uses a performance-based approach to standardize, automate, and streamline processes. By integrating various regtech applications, from machine-readable code that automates the processing of new regulations to image recognition that verifies identities, African countries can successfully identify their best course of action while continuing to adapt at speed as technology advances in their country. The World Economic Forum suggests asking three questions to better analyze what type of technology solution might be the most suitable for a country or company’s unique situation. These questions are: 1. What frictions exist in the regulatory process? 2. What is the nature of these frictions? 3. What processes could be improved to remove such frictions? These questions can help stakeholders identify entry points into the regtech arena and start the important process of integrating technologies into African regulatory ecosystems.

Third, African countries need to build trust through enhanced cybersecurity infrastructure, which will be key to expanding 4IR technologies throughout the financial services sector. Fraud and cyber threats have become increasingly prominent, with the financial services sector being the top sectoral target for cyberattacks in 2022-2023. For example, in South Africa, a data breach of millions of citizens’ social security information led to the creation of fake financial offers. To reduce the potential consequences of such data breaches and other cybercrimes, African governments need to focus on strengthening their cybersecurity infrastructure. To do so, African governments, financial institutions, and companies must work together to allocate resources for building defenses against cyber threats, including encryption tools, threat detection systems, endpoint security solutions, and training for employees and customers. Collaboration and proactive measures will be key to direct investment and regulatory harmonization toward building a resilient cybersecurity ecosystem.

Overall, African-led innovation within the financial services industry is catapulting the continent to the forefront of the industry, with important implications for digital inclusion and economic growth on the continent. As African countries continue to innovate, African governments and relevant stakeholders must focus on finding the right regulatory balance, integrating advanced technologies into their regulatory frameworks, and fortifying their cybersecurity infrastructure in order to further solidify their leadership role within the industry.

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This year, the economy saw surprisingly robust growth with real GDP on track to expand at a 1.8% annualized rate in the fourth quarter, closing 2024 with 2.3% annual growth, by our estimates. The biggest driver of this strength has been consumer spending, which contributed an average 78% of real GDP growth in the first three quarters. Despite pushing back on high retail prices, a thriftier consumer managed to stretch their budget and still expand their shopping cart. Inflation-adjusted consumer spending grew 3.0% year-over-year in 3Q, accelerating from 2.7% in 2Q, fueled by strong gains in real after-tax income. Consumption has been dominated by highincome households, which have enjoyed enormous gains in household wealth, along with strong interest, dividend and property income. Elsewhere, consumers have been more cautious but continue to spend. In the year ahead, continued progress in real wage growth should broadly support consumers, but consumption is likely to contribute less to growth going forward as the tailwind of pent-up savings and debt has largely faded.

Interest rate-sensitive sectors continued to face challenges but began to stabilize as interest rates peaked. The scope of its acceleration will depend on how much long-end yields move lower next year. Residential investment contracted in 2Q and 3Q as homebuilder sentiment struggled under elevated long-term interest rates, which may persist even as the Fed lowers the federal funds rate. The manufacturing sector, grappling with slow global demand, has also experienced weak job growth and new order activity. However, potential rate cuts could stimulate activity in these sectors, thereby broadening support for GDP growth.

Despite high borrowing costs, business investment has been buoyed by strong corporate balance sheets and fiscal support from legislation such as the CHIPS Act and the Inflation Reduction Act. Tech companies, in particular, have accelerated investment amidst an AI-arms race, and lower rates could facilitate similar investments across other sectors.

Economy: A Post-cycle Economy Faces Greater Policy Uncertainty_1

The labor market, while facing challenges such as recent hurricanes and strikes, is expected to remain healthy, with continued job gains and a stable unemployment rate at close to 4%. Employment growth has moderated and may stabilize at a monthly pace of 100,000 to 150,000, consistent with moderate employment growth and a down-shift in immigration. As the labor market normalizes, so too should the inflation rate. We anticipate headline PCE inflation to close the year at 2.3%, and then average 2.0% next year. Altogether, we expect real GDP to expand 2.1% year-over-year in 2025, marking its fifth consecutive year of expansion.

Policy shifts cast a fog of uncertainty on the outlook

The re-election of Donald Trump and the Republican sweep of Congress could lead to significant policy changes, casting a fog on the economic outlook. While the specifics and timing of potential policy shifts remain unclear, we anticipate tax cuts, higher tariffs, reduced immigration and deregulation of various sectors.

On the tax front, a full extension of the Tax Cuts and Jobs Act and the potential for a lower corporate tax rate for U.S.-based production seem most likely. Slim majorities in the Senate and House may limit a full implementation of proposed tax measures, but there could still be some items folded in on business tax provisions, tip income and the cap on SALT deductions. Regardless of any tariff budgetary offsets the administration may propose, these policies are likely to increase the deficit without significantly stimulating economic activity, adding to the nation’s long-term fiscal challenges.

An area of potential economic concern is the incoming Trump administration’s stance on tariffs. President-elect Trump has proposed a 10% tariff on all imports and a 60% tariff on all Chinese goods, which could be interpreted as a bargaining tool in trade negotiations. If these tariffs were enacted as stated, they could lead to higher inflation and reduce overall demand, as well as higher interest rates and a stronger U.S. dollar. According to a recent estimate by the Budget Lab at Yale, these tariffs would raise consumer prices by 1.4% to 5.1% before substitution, equivalent to the cost of $1,900 to $7,600 in disposable income for the average household.

Additionally, severely curtailed immigration could decrease real economic growth by limiting the growth of the labor force and may cause higher inflation through higher wages.

Lastly, it remains to be seen what the countervailing effect of lower regulations across various sectors is, especially the perspective for higher capital investment and hiring.

If we incorporate a rough expectation of these policy changes into our economic forecasts, the outlook shifts accordingly:

Real GDP would be largely unaffected next year, but tax cut stimulus kicking in at the start of 2026 could boost real GDP growth to 2.8% by the end of 2026.Job growth would be relatively unaffected in 2025 but labor markets would tighten. Lower labor force growth from less immigration would cut the unemployment rate to 3.9% by the end of 2025.Inflation, in terms of headline PCE, could rise to 2.7% by the end of 2025 in a one-time boost from tariffs then drift down to 2.1% by the end of 2026.The Fed could put a premature end to its easing cycle with just three more cuts, bringing the funds rate to 3.75%-4.00% by next summer and holding it there.

Policy forecasts at this stage are still highly speculative, but they don’t seem to spell disaster for the economy or markets in the short run. In the coming months, investors will look for greater clarity on the new administration’s agenda, which will help refine the economic outlook. Until then, the economy remains on stable footing as we enter the new year, with a gradual return to normal across many fronts. However, investors should remain vigilant, considering the fragility of the economic expansion that underpins a bullish fervor in markets.

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