UK Fiscal Policy: Permanently Living on the Edge?

Central Bank

Summary:

Reeves’ budget faces reality check.

Chancellor Rachel Reeves’ first budget in October 2024, with its increases in public expenditure, borrowing and taxation, was presented as a one-off ‘reset’ of fiscal policy, not to be repeated in the current parliament. This is too optimistic.

The planned growth in public expenditure after the 2025-26 financial year is, as with the previous government’s plans, unrealistically low. Either public spending will be higher, involving more borrowing or further increases in taxation, or there will have to be painful cuts in public services. This will come to a head when the government sets spending plans for departments for the years after 2025-26 in the spending round it is committed to carrying out in ‘late spring’ 2025.

Given the immense pressures for more spending – notably on health, defence, local authority services, the justice system and many investment projects – the 2025 spending round will reopen all the issues on spending, borrowing and taxation that the October budget was meant to settle.

Fiscal policy in the UK is better managed and on a more predictable path than in some other large economies. President-elect Donald Trump’s tax-cutting aspirations could increase further the historically high rate of public borrowing in the US. The German and French governments cannot get their legislatures to agree budgets for 2025, let alone the medium term.

Such uncertainties abroad at a time when most governments are financing their activities through high recourse to the bond markets does not mean that the UK can be assured of financing future deficits comfortably. There will be high levels of gilt redemptions to finance, and it is likely that the Bank of England will continue quantitative tightening, which will involve selling gilts in the market.

Against this background, the government should urgently consider further ways to ease its fiscal pressures beyond simply raising taxes or squeezing services. It should reverse the large fall in public sector productivity during the pandemic and finance increased infrastructure investment other than relying on gilt sales. This would necessitate a thorough revamp of the Private Finance Initiative. The last Labour government’s PFI was regarded as poor value for money and there were many complaints about aspects of the contracts. The initiative was eventually ended and not replaced. Instead, investment in infrastructure, such as in hospitals and schools, fell away – the worst possible outcome.

Restoring productivity levels

Focus on these reforms will be crucial as there will be strong resistance to tax increases for individuals and companies following the recent budget. There is mounting evidence that public sector efficiency and productivity in the UK fell sharply during the pandemic and have not fully recovered. According to the Office for National Statistics, at the beginning of 2024, public service productivity was over 6% lower than its pre-pandemic peak at the end of 2019.

Measuring the output and productivity of public services is notoriously difficult. The ONS stresses that its work in this area is still under development. Yet there is enough evidence to suggest that the fall in efficiency is a serious problem. Reversing it will take far more than setting modest annual efficiency targets of around 2% for government departments. It will require some drastic changes that would be difficult to achieve and uncomfortable for the workforce. But as the alternative is cuts in public services or further increases in taxes, it is the least bad option.

Much of the pre-budget discussion focused on changing the government’s fiscal rules to allow more borrowing for investment. The post-budget projections from the Debt Management Office show gross financing requirements (new borrowing plus refinancing of redemptions) in the range of £250bn to £300bn in each of the four financial years to 2028-29. The bulk of these will be met by gilt sales. At the same time, the Bank will be running off its stock of gilts (currently at a rate of £100bn per annum). This scenario may be feasible, particularly if the UK’s fiscal policy is perceived as relatively responsible by international standards. However, there are risks. Everything should be done to prevent a loss of confidence in the gilt market that could make a policy correction necessary.

Adapting to new investment models

It is ironic that governments, including the UK since 1694, invariably seek to finance even their legitimate financing requirements primarily through bond issuance. Yet despite the importance of the international bond market, recent decades have seen huge developments in other financial products and institutions. Many of these institutions are interested in infrastructure but have little or no appetite for UK government bonds. In financing their own activities, governments have not kept up with the changes in the international financial system.

Recent UK governments have tried to diversify from exclusive bond financing by tapping sovereign funds, insurance companies, pension funds, private equity and others to help fund infrastructure projects. The challenge is not so much to attract these investors as to find acceptable structures with adequate returns into which they might invest. Outright privatisation has been severely criticised, especially in the case of the water companies and train operators.

Since there will be future constraints on gilt-financed public sector investment, it would be preferable to design structures for private finance that reduce or minimise the previous problems with private finance. As with the need to improve public sector productivity, designing acceptable structures for private finance is primarily a task for government. An ambitious public sector efficiency programme and a reformed PFI need to be in place before next year’s spending round if service cuts and tax increases are to be avoided.

Source:Peter Sedgwick

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Economic

Bond

Corporate Bonds: A Stable Income Opportunity Amid Tightening Spreads and Global Economic Divergence

Corporate bonds, whether through individual investments or ETFs, offer a compelling option for diversifying your portfolio and earning stable income in a challenging economic environment. By understanding the basics, assessing the macroeconomic landscape, and choosing suitable ETFs, investors can navigate the bond market with confidence and achieve their financial goals.

U.S., corporate bonds—both high-yield (HY) and investment-grade (IG)—have seen their spreads narrow to levels not seen since before the global financial crisis, reflecting strong investor confidence in the U.S. economy. Credit spreads refer to the difference in yield between corporate bonds and risk-free government bonds of similar maturity. This spread compensates investors for the additional risk of lending to a corporation instead of a government. When spreads tighten, it signals increased investor confidence and demand for corporate bonds, as the perceived risk of default decreases.

In Europe, credit spreads are also trading near the bottom of their 17-year range but have not tightened as substantially as U.S. corporate spreads. This disparity can be attributed to the relatively sluggish performance of the European economy compared to the robust growth in the U.S., which has made investors more cautious about taking on additional credit risk in Europe. This divergence highlights how regional economic dynamics influence the corporate bond market, making it essential for investors to consider these factors when building their portfolios.

Corporate Bonds Explained: Income and Security for Your Portfolio_1

Why Are Investors Focusing on Corporate Bonds Now?

Navigating a Complex Macroeconomic Environment

In today’s challenging economic climate, corporate bonds are gaining popularity as investors seek stability and income amid uncertainty. Here’s why:

Inflation Protection: Inflation that remains sticky and elecated erodes the value of future cash flows. Corporate bonds, especially high-yield ones, can offer higher yields that help cushion the impact of inflation.

Monetary Policy Uncertainty: Central banks, including the Federal Reserve and the European Central Bank, are navigating uncertain economic conditions. Rate hikes and unexpected policy moves can shake markets, making corporate bonds an attractive buffer against volatility.

Diversification: Corporate bonds often have a low correlation with equities, providing a stabilizing effect in turbulent markets.

Credit Quality Matters: Investment-grade corporate bonds are seen as a safer haven for risk-averse investors, while high-yield bonds can be appealing for those seeking greater returns in exchange for taking on additional risk.

The Appeal of Corporate Bonds Amid Market Volatility

Corporate bonds provide:

Income: Regular coupon payments offer a predictable income stream.

Capital Preservation: Bondholders are prioritized over shareholders in case of bankruptcy, making corporate bonds a relatively safer investment.

Flexibility: Bonds can be held to maturity for predictable returns or traded in the secondary market for potential capital gains.

What Does It Entail to Invest in Corporate Bonds?

Corporate bonds are a way for investors to lend money to companies in exchange for periodic interest payments (known as coupons) and the return of the bond’s face value at maturity. These instruments are typically less risky than stocks but can provide steady income and capital preservation, making them a popular choice for diversifying portfolios.

How Corporate Bonds Work: When you invest in a corporate bond, you’re essentially giving a company a loan. The company promises to pay you interest (the coupon) and repay the principal amount at the end of the bond's term. For example, a 10-year bond with a 5% coupon purchased for $1,000 would pay you $50 annually until maturity.

Why Companies Issue Bonds: Companies use bonds to raise capital for projects, acquisitions, or refinancing debt. Issuing bonds is often cheaper and more flexible than obtaining a bank loan or issuing additional stock.

Types of Corporate Bonds:

Investment Grade (IG): Lower-risk bonds issued by companies with strong credit ratings.

High-Yield (HY): Higher-risk bonds issued by companies with lower credit ratings, offering higher returns to compensate for the increased risk.

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JPMorgan

Economic

I’ve been running my own econometric model of the U.S. economy for almost 30 years now. The basic structure is simple. You start by forecasting the components of demand, that is to say, consumption, investment, trade and government spending. This gives you an initial projection of real GDP growth. You then feed this into labor market equations, along with some demographic assumptions, to forecast the growth in jobs, the unemployment rate and wage growth.

All of this, along with assumptions about energy prices and the dollar, then drive forecasts of inflation. Given this outlook for growth and inflation, you make an assumption about the path for the federal funds rate and then run forecasts of other interest rates. With all of this in hand, you can forecast productivity, corporate profits, the federal budget deficit and household net worth. And then you go back to the start to see how all these changes impact your original demand forecast. You repeat the process until you arrive at a reasonably consistent solution.

There are, of course, many details to each of these steps and, over the years, I’ve tended to add complexity to the model rather than reduce it. This is the time of year when I most regret that tendency since, each fall, after the government releases its annual benchmark GDP revisions, I overhaul the model and add another year to the forecast. This is a very cumbersome process and this year I delayed it for a month or two on the grounds that the election might significantly impact the forecast – which it has.

Still, over the last week, I’ve had to bite the bullet and extend the forecast out to 2026, including some important assumptions about the effects of potential policy changes in Washington, particularly in the areas of tariffs, immigration and taxes.

The Forecast without Policy Changes

In order to assess the potential impact of policy changes, it makes sense to first consider what the forecast would have looked like in their absence. A year ago, we summarized our outlook for 2024 as 2-0-2-4, that is to say, 2% real GDP growth, zero recessions, inflation falling to 2% and the unemployment rate staying at or below 4%.

This forecast has worked out pretty well – we now expect fourth quarter data to show year-over-year real GDP growth of 2.2%, year-over-year consumption deflator inflation of 2.3%, an unemployment rate of 4.1% and we have, of course, avoided recession.

In the absence of policy change, the model suggests something very similar for both 2025 and 2026, with real GDP growth and inflation averaging close to 2%, the unemployment rate staying at 4% and the economy continuing to dodge recession.

However, this forecast is really the result of a fine balance among offsetting factors. Consumer spending is being boosted by positive real wage growth, improving consumer confidence and a continuing surge in wealth. That being said, slower job growth, rising consumer credit delinquencies and lower immigration (even before the change in administration) was set to slow consumer spending growth to 2.0% from the 3.0% achieved over the past year. Investment spending growth was also on track to moderate in a lagged reaction to higher interest rates, trade was set to detract from growth due to a high dollar and weakness overseas and state and local government spending was likely to grow more slowly following a delayed post-pandemic hiring spree.

This moderating economic growth would imply moderate employment growth of roughly 100,000 to 150,000 jobs per month. Given a drift down in immigration and stagnant growth in the native-born working age population, this should have been enough to hold the unemployment rate close to 4.0%.

Meanwhile, in the absence of policy change, inflation should also have been largely stable with consumption deflator inflation sticking close to 2.0% year-over-year after seeing a small bump higher over the next few months.

This view of the world is very close to that laid out by the Federal Reserve at its September meeting and would be consistent with a slow normalization of interest rates cutting the federal funds rate from a peak of 5.25%-5.50% to a range of 2.75%-3.00% by the summer of 2026.

Potential Policy Changes

So how might potential policy changes impact this outlook?

On tariffs, the President-elect has vowed to impose a 10% tariff on all imported goods and a 60% tariff on Chinese goods. However, roughly 38% of goods are imported from countries with whom the United States has a free-trade agreement, most notably Canada and Mexico, which bar this kind of unilateral tariff increase. If we exclude these countries, the average tariff rate on imported goods would rise from roughly 3.0% today to 11.8%, or an increase of 8.8%. However, we assume that because of negotiations with some trade partners, business pressures to exempt some commodities, and foreign suppliers and importers eating some of the cost, the average price of imported goods would only rise by half as much, or 4.4%, starting in the second quarter of 2025. With U.S. goods imports equal to 17% of consumer spending, this could, as a very rough estimate, add 0.7% to CPI inflation next year.

Tariffs would also reduce both imports and exports. Assuming that foreign nations retaliated with equivalent tariffs, both sides of U.S. trade could decline by equivalent percentages. Because the U.S. imports more than it exports this could, in theory, add to economic growth. However, the impact of a trade war in slowing the global economy and the uncertainty and disruption caused by a further need to reroute supply chains, would likely more than negate this effect.

On immigration, while campaign rhetoric was extreme, we expect actions to be less so. The newly-named “border czar”, Tom Homan, has emphasized that he will prioritize deporting undocumented immigrants with criminal convictions and final deportation orders. This group likely has much lower labor-force participation than other immigrant groups. Consequently, we do not expect a sharp decline in labor force from deportations.

That being said, the election may discourage people from crossing the border as well as dampening more traditional immigration. In addition, legal avenues to immigrate may be slowed or restricted as was the case in the first Trump administration. It is quite possible that the picture could change with the passage of an immigration reform bill. However, for now, we are assuming that a crackdown on immigration cuts labor force growth by 25,000 per month or 300,000 per year – or roughly a quarter of net immigration in the year ended June 2023.

On taxes, in 2025, we expect the omnibus reconciliation bill, which is the one budgetary vehicle with immunity from Senate filibusters, to contain very significant tax cuts. This bill will likely contain a full extension of the 2017 TCJA cuts that were set to expire at the end of 2025. The President-elect has also promised a cut in the capital gains tax from 21% to 15% for domestic production, a restoration of full expensing of R&D and equipment purchases, also for domestic production, removal of the cap on SALT deductions, deductibility of auto loan interest and exemptions from income tax for all social security, tips and overtime income. Based on calculations from the Committee for a Responsible Federal Budget, we estimate that a full implementation of these plans would add more than $5.0 trillion to the federal debt over 10 years, on top of a simple extension of tax policy as it is currently being implemented. This could amount to over $400 billion in additional annual fiscal stimulus and deficit financing, kicking in at the start of 2026.

However, Congress will very likely attempt to reduce the costs of these proposals. It could, for example, raise rather than eliminate the cap on SALT deductions and means test the tax breaks on social security, tips and overtime. For now, we are assuming an annual $200 billion boost in fiscal stimulus and deficits from changes in the tax code starting in 2026.

Implications for the Macro Outlook and Investing

Some would argue that we should also boost estimates of productivity from deregulation under a new Trump administration. However, any such gains are very hard to estimate and could be offset by the distortions caused by readjusting supply chains in reaction to tariffs, finding ways to define production as domestic, trying to replace deported immigrants, and maximizing the income that could be categorized as tips and overtime for taxes. So in incorporating policy changes into the forecast, we only, at this stage, include assumptions on the inflation hit from tariffs, the labor force hit from tougher immigration policy and the income and deficit impacts of tax cuts.

The net result of this is to somewhat destabilize a very stable forecast.

Economic growth, would be largely unaffected next year, with real GDP rising by 2.2% year-over-year by the fourth quarter of 2025. However, powerful fiscal stimulus from tax cuts kicking in at the start of 2026 could boost year-over-year real GDP growth to 2.8% by the end of the year.

Job growth, would also be relatively unaffected in 2025 but would pick up in 2026 in response to fiscal stimulus. Lower labor force growth due to less immigration would cut the unemployment rate to 3.9% by the end of 2025 and 3.6% by the end of 2026

Inflation, as measured by the personal consumption deflator, could rise to 2.7% year-over-year by the fourth quarter of 2025 in a one-time feed-through effect from tariffs and then drift down to 2.1% year-over-year by the end of 2026.

Meanwhile, the Federal Reserve, could, as the market now anticipates, put a premature end to its easing cycle with just three more 25-basis-point rate cuts, taking the federal funds rate down to a range of 3.75% to 4.00% by next summer and holding it there. Needless to say, our fiscal situation would worsen, with the federal budget deficit potentially rising from $1.8 trillion in fiscal 2024 to $2.7 trillion, or 8.4% of GDP, in fiscal 2026.

It should be stressed that all of this is highly speculative. We do not know the details on any of these policies or how aggressively the new administration will pursue them. That being said, on a very rough forecast, none of this spells disaster for the economy or markets in the short run and equities could directly benefit from a further reduction in the corporate income tax.

However, it does suggest that, barring a recession, long-term Treasury yields and mortgage rates are more likely to drift up than down from here. Moreover, further weakening our already stressed public finances adds long-term risk to any investment scenario. For this reason, and because both U.S. equities and the dollar have risen substantially over the course of this election year, now would be a good time for investors to consider broader diversification both among U.S. assets and around the world.

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

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UBS

Economic

As we explore these thriving hubs, we will examine how they have cultivated an attractive environment for startups and consider the role of major players in the healthcare sector, particularly in Switzerland, while also reflecting on the dynamics of these ecosystems.

Swiss Valley: a biotechnology powerhouse

The geography of innovation

Nestled between Zurich, Basel, and Lausanne, ‘Swiss Valley’ is a dynamic stretch that encompasses some of the most significant research and development institutions in Europe. At the heart of this innovation ecosystem is ETH Zurich, one of the most prestigious technical universities worldwide, well-known for its engineering and life sciences programs. The university fosters a robust entrepreneurial spirit, offering support to startups through dedicated incubators and mentoring programs.

Further downstream, Basel houses industry giants such as Novartis and Roche. These multinational pharmaceutical companies are not just significant players in the global market; they also play an integral role in the Swiss venture capital landscape by acquiring small, innovative biotech firms. These acquisitions allow major players to absorb advancements in technology and research, fueling their growth and extending their pipeline of innovative products.

Navigating healthcare and life sciences

The healthcare and life sciences sectors hold a unique position in Switzerland's innovation ecosystem. Key regional clusters include the BioValley in Basel, the Bio-Technopark Zurich and the Biopôle in Lausanne, each fostering biotech research in their own domain. With an increasing demand for innovative healthcare solutions, Switzerland has become a magnet for startups focused on life sciences, medical devices, and pharmaceuticals. According to the 2024 Swiss Venture Capital Report, Swiss biotech companies received VC investment to the tune of CHF 488 million in 2023 alone, a twenty percent year-on-year growth compared to 2022. Established firms, including Johnson & Johnson and Novo Nordisk, strategically acquire emerging companies to access groundbreaking research and expedite their product development cycles. Recent success stories, including NBE-Therapeutics (acquired for EUR 1.18 billion by Boehringer Ingelheim) or VectivBio (acquired for USD 1 billon by Ironwood Pharmaceuticals), are testimony to a robust exit environment.

Investments in Switzerland's startup scene have been bolstered by tax incentives and favorable regulations, encouraging private equity firms and institutional investors to funnel their ‘dry powder’ into promising ventures. Startups are increasingly focused on developing tools for personalized medicine, AI-driven diagnostics, and novel therapies, indicating a strategic shift towards cutting-edge solutions that respond to global healthcare challenges.

The rise of silicon canals in Amsterdam

Amsterdam's flourishing startup ecosystem

Amsterdam is rapidly defining its identity as a leading European innovation hub. Dubbed ‘Silicon Canals’, this vibrant tech landscape is characterized by its diverse startup ecosystem powered by seasoned entrepreneurs and an influx of talent, supported by a collaborative environment that fosters networking and knowledge-sharing.

The University of Amsterdam and Amsterdam University of Applied Sciences are vital contributors to this ecosystem, producing a steady stream of talented graduates in technology and business. From fintech companies to green tech startups, the city's entrepreneurs are increasingly focused on addressing pressing global issues, such as sustainability and urbanization.

Supportive infrastructure and resources

Key initiatives by the Dutch government, coupled with the efforts of private incubators and accelerators, have provided startups access to vital resources. Programs like StartupAmsterdam and various accelerators have contributed to the thriving environment, making it easier for entrepreneurs to collaborate with venture capitalists and industry veterans. Notably, the presence of numerous co-working spaces and incubators fosters a culture of innovation and collective growth.

The Amsterdam region is home to several VC firms that have been allocating increasingly larger portions of their dry powder to local startups. In 2023 alone, North American investments in European technology reached an all-time high, demonstrating the growing allure of European markets for global investors. This influx of capital and the availability of talent are critical components driving Amsterdam's emergence as a significant VC hub.

According to Dealroom, Amsterdam now counts 12 companies valued over USD 1 billion, since the early Booking.com success story: almost one per year on average, but almost two every year since 2019. Recent Dutch unicorn success stories include Adyen, Elastic, Takeaway.com, Mollie and WeTransfer.

Sweden's growing innovation landscape

A hub of startups and incubators

Sweden has established itself as another key player in the VC arena, with a burgeoning ecosystem of startups and incubators. The country boasts a rich tradition of innovation, spurred by its strong education system and extensive research institutions such as the Karolinska Institute and KTH Royal Institute of Technology. The Wharton School of Business called Sweden a “unicorn factory” in a 2015 study and one year later TechCrunch dubbed Sweden the “tech superstar from the north.”

Swedish VC has increasingly flowed into promising startups, particularly those focused on technology, sustainability, and healthcare. Initiatives like STING (Stockholm Innovation & Growth) and Startup Sweden serve as incubators, providing support, mentorship, and funding for nascent companies. These programs play a crucial role in connecting entrepreneurs with venture capitalists and experienced industry mentors, laying the foundation for sustainable growth.

In 2018, Sweden saw two of its major tech success stories come to full fruition with Spotify’s USD 27 billion IPO and iZettle’s acquisition for USD 2.2 billion by PayPal. As for many other European innovation clusters, major exit outcomes like this can help to attract more capital into the region and inspire the next generation of founders.

Robust focus on sustainability

The Swedish startup ethos is significantly influenced by a strong commitment to sustainability, which leads to a diverse array of innovative projects aimed at addressing climate change and fostering sustainable development. With an increasing emphasis on environmental, social, and governance (ESG) criteria, venture capitalists are incentivized to prioritize investments in companies that align with sustainable practices. This trend reflects a broader evolution in the VC landscape, where climate tech is not just a niche but a critical focus area for many investors.

VC activity in Europe: key figures

To enhance our understanding of the VC dynamics within Europe, we can analyze the number of deals and aggregate deal values across major European countries for early and late-stage VC investments (see Figures 2 and 3). The charts display the breakdown by country and vintage year for both the number of deals and aggregate deal values.

Analyzing the data offers valuable insights into the VC landscape in Europe:

UK dominance: The UK continues to maintain a leading position in both the number of deals and aggregate deal value, indicating a robust ecosystem that attracts significant investment across a diverse array of sectors. Its VC environment is supported by an established network of investors, accelerators, and a vibrant startup community.

Switzerland's growth: Switzerland has experienced a notable increase in its share of both the number of deals and aggregate deal value, particularly rising from 6.5% in deal numbers in 2020 to 7.8% in 2024 YTD. This growth reflects a rising interest in Swiss startups, particularly in biotech and health tech sectors, reinforced by the presence of major pharmaceutical firms and research institutions that nurture innovation.

Nordics potential: The Nordics also display promising growth trends, with an increase in the number of deals from 7.6% in 2020 to 8.4% in 2024 YTD. The region’s strong emphasis on sustainability and technology-driven solutions continues to attract VC investments, supporting a thriving startup ecosystem that is well-positioned for future growth.

The competitive landscape of European VC

Funding trends and dry powder dynamics

As of October 2024, European VC funds boast a total dry powder of approximately USD 47.2 billion (see Figure 1). These capital reserves are pivotal for the growth of startups, especially when market conditions tighten or economic uncertainties loom.

A significant observation in the current funding environment is the disparity in investment levels between regions. North America leads with a staggering USD 250.2 billion, while Asia follows closely with USD 235.5 billion. Comparatively, Europe, with USD 47.2 billion, may seem smaller but represents a burgeoning opportunity particularly with the backing of government initiatives and a commitment from institutional investors to diversify their portfolios.

Over the past few years, European VC has seen considerable growth, particularly in sectors such as technology, healthcare, and fintech. This growth has been supported by both local and foreign investments, suggesting that European VC firms are likely to prioritize high-potential startups, creating a positive feedback loop of funding innovation.

Key players in the European VC landscape

Leading VC firms across Europe have significantly influenced the direction of investments. Firms such as Balderton Capital, Index Ventures, and Northzone have established themselves as pivotal players, focusing on a wide array of technology-driven startups across various sectors.

Additionally, family offices and sovereign wealth funds have begun to actively participate in the European VCscene, offering a new pool of capital to startups. This diversification of investor profiles contributes to a vibrant environment where innovation can thrive.

Challenges and opportunities

Competition and market saturation

Despite the promising growth, European VC faces several challenges. As more funds enter the market, competition for the best investment opportunities intensifies. Startups often encounter difficulties in securing financing, particularly when competing against well-established firms with longer track records and better access to capital.Moreover, ongoing geopolitical tensions and economic uncertainties can affect investor sentiment, potentially leading to fluctuations in funding availability. Startups may need to pivot quickly or exhibit greater adaptability to maintain investor confidence.

Room for growth

Nevertheless, there are ample opportunities for growth within Europe. Markets in Central and Eastern Europe are beginning to reveal their potential as emerging startup ecosystems, offering a unique blend of innovation and lower competition. VC firms that strategically tap into these emerging markets could uncover new avenues for investment and growth.Furthermore, partnerships with academic institutions and industry leaders can facilitate collaborations that foster startup growth. By bridging the gap between research and commercialization, stakeholders can expedite the development of innovative solutions that meet market demands.

Focus on healthcare innovations

The healthcare and life sciences sectors continue to be focal points for VC investments. The COVID-19 pandemic underscored the need for rapid innovation in healthcare, and this demand is unlikely to dissipate. Startups that focus on telehealth, biotechnology, AI in healthcare, and digital health solutions are poised for significant growth, and venture capitalists are taking note.

Switzerland's strong legacy in life sciences, coupled with the EU's increasing emphasis on healthcare innovation, ensures that opportunities abound for investors willing to support promising healthcare ventures that demonstrate innovative approaches to disease management and patient care. The emphasis on preventative care, personalized medicine, and the integration of technology in health management presents a multitude of avenues for investment and growth in this sector.

Emerging trends in European venture capital

Rise of health tech and biotech

Health tech and biotech sectors within European VC continue to experience robust growth. The COVID-19 pandemic accelerated digital adoption in healthcare, giving rise to numerous startups specializing in telemedicine, health data analytics, and remote patient monitoring. Investments in these areas are expected to increase as healthcare systems and patients recognize the long-term benefits of innovation and technology in improving health outcomes.

Biotech is thriving, particularly in ‘Swiss Valley’, where collaboration between universities, research institutions, and industry leaders facilitates the rapid translation of laboratory findings into marketable solutions. Startups developing new therapies, vaccines, and CRISPR-based technologies are attracting significant attention from investors looking to fund the next breakthrough in medical science, reinforcing Switzerland's position at the forefront of biopharmaceutical innovation.

In a recent discussion with Peter Pilavachi, a GP of the PA MedTech VC fund Peter described some of the advantages Switzerland enjoys and the challenges faced by European companies in this sector:

“Switzerland’s success is built on its world-class education system and its ability to coordinate essential resources ‒ start-up infrastructure, financing, and, crucially, a business-friendly fiscal and regulatory environment. Switzerland excels in the pharmaceutical sector, whereas the US maintains a clear edge in MedTech, led by major strategics such as Johnson & Johnson, Medtronic, and Boston Scientific.

Most of Europe lags behind the US in key areas of this technology race and obtaining regulatory approval in the EU is slower, with many European MedTech companies prioritizing FDA approval over CE mark certification. The FDA’s approach is business-friendly and in general the US is more entrepreneurial, with better access to financing and has a more favorable tax environment. Entrepreneurs, being highly mobile, often relocate to jurisdictions with better incentives, contributing to brain drain in some European countries.“

Sustainability and climate tech initiatives

With Europe grappling with climate change, there has been a massive push toward sustainability and climate tech investments. The European Union has set ambitious targets for reducing greenhouse gas emissions, which has incentivized startup creation in areas such as renewable energy, waste management, and carbon capture technologies. Venture capitalists are increasingly focusing on companies that not only generate strong financial returns but also contribute positively to addressing climate issues.

Startups like Oatly in Sweden, which focuses on sustainable food alternatives, have gained traction and demonstrated the potential for VC investments to drive meaningful change. As consumers demand more sustainable products, VC firms are integrating ESG criteria into their investment strategies, fostering a new wave of innovation that tackles climate challenges while delivering financial returns.

Final thoughts

As Europe cultivates its VC landscape, regions such as ‘Swiss Valley’, ‘Silicon Canals’, and Sweden's burgeoning ecosystem represent the convergence of academia, industry, and entrepreneurship. While competition and market saturation pose challenges, the vast potential for innovation and growth in healthcare, technology, and sustainability presents untapped opportunities for investors.The dynamic interplay between established pharmaceutical giants absorbing smaller innovators and burgeoning startups creating disruptive technologies paints an exciting picture of the future of VC in Europe. As institutional investors, private equity specialists, and finance professionals continue to explore Europe, they will find lively hubs rich with potential and a community eager to drive the continent's next wave of innovation.

The right investments can position Europe as an important player in advancing innovation and sustainable growth. The time is ripe for investment in a future defined by creativity, collaboration, and transformative breakthroughs.

The journey ahead will require stakeholders to secure a balance between nurturing nascent startups and maintaining an agile, competitive posture. By acknowledging the inherent challenges and embracing the multitude of opportunities outlined, investors and entrepreneurs alike can harness the collective power of these innovation hubs to foster a new era of venture capital that promises profound societal impact and sustained economic advancement.

As Europe pushes forward, its commitment to innovation, sustainability, and collaboration will be crucial in shaping the trajectory of its VC landscape, ensuring that it remains a fertile ground for up venture firms.

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

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ACY

Economic

Australia's economy in 2024 has been marked by subdued GDP growth—the weakest outside the COVID-19 period—paired with persistently high inflation and elevated interest rates. However, prospects for 2025 suggest a cautiously optimistic recovery, driven by several supportive factors.

GDP Australia

One of the main drivers of this anticipated rebound is the expected easing of interest rates. Lower rates are likely to stimulate household spending and encourage business investments, laying a foundation for growth. Simultaneously, real household incomes are set to rise, helped by reduced inflationary pressures and targeted tax relief. These improvements, along with a recovering housing market, are expected to boost consumer confidence, with rising property values providing positive wealth effects. Additionally, sustained structural investments in infrastructure and renewable energy projects are likely to support economic activity.

Monetary Policies

Despite these encouraging trends, growth is projected to remain below its potential, and the unemployment rate is anticipated to peak at 4.6% by mid-2025. While this slight increase signals softening in the labour market, it is expected to play a role in moderating wage growth and inflation. In fact, trimmed mean inflation is forecast to stabilize within the Reserve Bank of Australia’s (RBA) target range of 2-3% by late 2024, creating favourable conditions for economic recovery.

Key sectors are likely to contribute differently to this growth. Household spending is expected to recover from a low base, with annual growth predicted to reach 2.0% by the end of 2025. Residential construction will see a modest recovery, aided by lower input costs and stronger house prices. Business investment, particularly in public infrastructure and renewable energy, is forecast to grow at a steady annual rate of 3%. Conversely, government expenditure may slightly decline due to policy changes, including adjustments to programs like the National Disability Insurance Scheme and the expiration of electricity subsidies. In trade, strong commodity exports are anticipated to offset slower growth in education-related services due to capped international student arrivals.

Australia’s monetary policy is also poised for a shift. Having lagged its global peers in normalizing post-COVID, the RBA is now aligned with G10 economies. With inflation easing, the RBA is expected to begin lowering interest rates in early 2025, potentially reaching a terminal rate of 3.25% by November. This reduction is likely to provide a much-needed stimulus to the economy.

However, risks to this outlook remain. Global trade uncertainties, potential policy shifts, and geopolitical events could influence the trajectory of Australia’s economic recovery and the timing of monetary policy adjustments.

In summary, while challenges persist, Australia’s economy is positioned for gradual improvement in 2025. Supportive domestic policies, a stabilizing inflationary environment, and targeted investments offer hope for a steady recovery, fostering long-term growth and resilience.

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Goldman Sachs

Economic

Worldwide GDP is forecast to expand 2.7% next year on an annual average basis, just above the consensus forecast of economists surveyed by Bloomberg and matching the estimated growth in 2024. US GDP is projected to increase 2.5% in 2025, well ahead of the consensus at 1.9%. The euro area economy is expected to expand 0.8%, compared to the consensus of 1.2%.

“Global labor markets have rebalanced,” Goldman Sachs Research Chief Economist Jan Hatzius writes in the team’s report titled “Macro Outlook 2025: Tailwinds (Probably) Trump Tariffs.” “Inflation has continued to trend down and is now within striking distance of central bank targets. And most central banks are well into the process of cutting interest rates back to more normal levels.”

The world’s largest economy is expected to grow faster than other developed-market countries for the third year in a row. The re-election of US President Donald Trump is predicted to result in higher tariffs on China and on imported cars, much lower immigration, some fresh tax cuts, and regulatory easing. “The biggest risk is a large across-the-board tariff, which would likely hit growth hard,” Hatzius writes.

The Global Economy is Forecast to Grow Solidly in 2025 Despite Trade Uncertainty_1

Will changes in trade increase US inflation?

US core PCE inflation should slow to 2.4% by late 2025, higher than Goldman Sachs Research’s prior forecast of 2.0% but still a benign level. The forecast would rise to around 3% if the US imposes an across-the-board tariff of 10%. In the euro area, our economists expect core inflation to slow to 2% by late 2025. The risk of ultra-low inflation in Japan has abated.

“A key reason for optimism on global growth is the dramatic inflation decline over the past two years,” Hatzius writes. “This directly supports real income because price inflation has fallen far more quickly than wage inflation.”

“Just as importantly, the inflation decline also indirectly supports demand by allowing central banks to normalize monetary policy and thereby ease financial conditions,” he adds.

Goldman Sachs Research expects the US Federal Reserve to cut its policy rate to 3.25-3.5% (from 4.5% to 4.75% now), with sequential cuts through the first quarter and a slowdown thereafter. The European Central Bank, meanwhile, is expected to lower its policy rate to a terminal rate of 1.75%. Our economists find that there’s also significant room for policy easing in emerging markets. By contrast, the Bank of Japan is projected to lift its policy rate to 0.75% by the end of 2025.

How will Trump’s trade policy impact the US economy?

The effects of potential new US trade policies on US GDP are expected to be small and largely offset by other factors, according to Goldman Sachs Research’s baseline outlook. Potential tariffs would result in a modest hit to real (inflation adjusted) disposable personal income via higher consumer prices. The uncertainty of how much further trade tensions might escalate would likely weigh on business investment.

“Assuming that the trade war does not escalate further, we expect the positive impulses from tax cuts, a friendlier regulatory environment, and improved ‘animal spirits’ among businesses to dominate in 2026,” Hatzius writes.

The Global Economy is Forecast to Grow Solidly in 2025 Despite Trade Uncertainty_2

In Goldman Sachs Research’s base case, trade policies may have a net drag of 0.2 percentage points on US GDP in 2025. If larger than anticipated across-the-board tariffs are implemented, that could cause a net drag averaging 1 percentage point in 2026 (though it could be lower if tariff revenue is fully recycled into tax cuts).

The US has grown faster than other big economies and is predicted to continue doing so. Goldman Sachs Research points out that labor productivity in the US has increased at a 1.7% annualized rate since late 2019, a clear acceleration from the pre-pandemic trend of 1.3%. By contrast, labor productivity in the euro area has grown at a 0.2% annualized rate over the same period, a clear deceleration from 0.7% before the pandemic.

“We expect US productivity growth to remain significantly stronger than elsewhere, and this is a key reason why we expect US GDP growth to continue to outperform,” Hatzius writes.

How US trade policies may affect other economies

The economic headwind from US trade policy is expected to be greater outside the US. In the euro area, a rise in trade policy uncertainty to the peak levels of the trade conflict in 2018-19 would subtract 0.3% from GDP in the US but as much as 0.9% in the euro area.

Our economists reduced their growth forecast for the euro area in 2025 following the US election results by 0.5 percentage points (fourth quarter over fourth quarter) and would likely cut it further if the US imposes an across-the-board tariff. The Global Economy is Forecast to Grow Solidly in 2025 Despite Trade Uncertainty_3

The Global Economy is Forecast to Grow Solidly in 2025 Despite Trade Uncertainty_3

Goldman Sachs Research expects the impact of potential US trade policy on China to be even more direct. The world’s second-largest economy may face tariff increases of up to 60 percentage points and average 20 percentage points across all exports to the US. That’s forecasted to subtract almost 0.7 percentage points from growth in China in 2025. Our economists reduced their 2025 growth forecast modestly, by 0.2 percentage points on net to 4.5%, assuming Chinese policymakers provide stimulus and some of the growth hit is offset by depreciation in the renminbi.

“However, we would likely make larger downgrades if the trade war were to escalate further,” Hatzius writes.

The Global Economy is Forecast to Grow Solidly in 2025 Despite Trade Uncertainty_4

Likewise, other countries are also likely to be buffeted by US trade policy. Goldman Sachs Research expects larger drags in more trade-exposed economies, while certain emerging market countries could get a boost by gaining export share if trade shifts away from China.

Overall, however, global economic growth is expected to be solid despite the potential for US tariffs. Our economists estimate that changes to US trade policy will subtract 0.4% from global GDP, while increased policy support should dampen the hit. But much depends on the size of any new trade restrictions. The impact could be two to three times larger if the US imposes a 10% across-the-board tariff.

“Barring a broader trade war, policy changes in the second Trump administration are unlikely to change the broad contours of our global economic views,” Hatzius writes.

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ING

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Forex

Breakout

As many had been fearing and our team had been writing this week, today’s softer-than-expected European PMI numbers have proved the catalyst for a downside breakout in the euro. The numbers feed into the narrative that European business confidence is crumbling – or at least sees no way out of stagnation – in an environment of looming trade wars and political gridlock in Europe.

Our team have been saying it for a while now, but it looks like European Central Bank rate cuts will have to do the heavy lifting again when it comes to supporting the eurozone economy. Today’s data triggered an 8-10bp drop in short-dated eurozone swap rates, pushing the ‘Atlantic’ rate differential to the widest levels of the year. The market is now starting to lean towards our house view of a 50bp ECB rate cut in December and bake in a sub-neutral 1.75% ECB policy rate for next summer.

When we lowered our EUR/USD forecasts earlier this month, this was largely on the view that US:eurozone rate spreads would widen and a risk premium from trade wars would be built in later in 2025. Actually, we’re having an internal debate as to whether that risk premium should be built in earlier.

At the same time, the escalation in the Russia-Ukraine war this week has added to euro downside. The understandable fear now is that this crisis escalates into year-end as both sides try to secure the best possible positioning ahead of potential Trump-led ceasefire discussions in January. Unlike in 2022, energy prices have been remarkably subdued, although we are starting to see European natural gas prices creep higher again – a clear negative for European currencies.

The two main arguments against much further EUR/USD downside are that EUR/USD has come a long way already and that the dollar normally weakens in December. On the former, the near 7% drop in just two months is exceptional. Could this fire up the ECB hawks who might be worried about imported inflation, or least prompt some kind of comments from ECB officials about a speed of adjustment that has been too quick for European businesses? We would not rule it out, but at most such comments should slow not reverse the current EUR/USD drop.

How far could EUR/USD fall? As Francesco Pesole wrote yesterday, EUR/USD is now a little undervalued based on our medium-term BEER model – but that doesn’t preclude a move to parity. Now that the 2023 1.0448 EUR/USD low has been broken, we certainly see scope to the next support zone down at 1.0190/0200.

And in terms of positioning, our colleagues in the FX Options team suggest that investors might not be as short EUR/USD as much as they had hoped after downside barriers have been triggered today – these barriers having been used to cheapen downside FX options structures but, by being triggered, have now cancelled those downside EUR/USD structures altogether.

EUR/USD breaks to the downside of exceptionally tight range

EUR/USD: Macro and Geopolitics Align for a Downside Breakout_1

Volatility regime change?

The narrow EUR/USD ranges of the last two years have been the exception rather than the rule. And it is tempting to say that the advent of Trump 2.0 – or Trump unleashed, as many commentators are calling it – can usher in a period of higher volatility. Certainly the EUR/USD FX options market is taking note and has pushed one year EUR/USD traded volatility up to the highest levels since October.

What holds us back from concluding that yes, we expect structurally higher levels of FX volatility in 2025, is that the peak Trump trade wars of 2018-2019 saw EUR/USD traded volatility actually decline. Here, it seems investors got used to Trump protectionism back in 2018/19. The difference in 2025, however, is that we could be talking a global trade war and not just protectionism against China, which was the case in 2018-19.

We also note in the chart above that EUR/USD is breaking to the downside from a historically low volatility environment – a warning of a volatility regime change.

Given the heavy macro/geopolitical factors favouring the downside and the fact that EUR/USD is not particularly undervalued based on our medium term models, we certainly do not want to stand in the way of a EUR/USD move to parity nor fight the rise in higher traded volatility levels.

Source:ING

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EUR/USD: Macro and Geopolitics Align for a Downside Breakout

Breakout

EUR/USD breaks to the downside of exceptionally tight range

Volatility regime change?

Source:ING

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