Central banks recalibrate; activity cools; shocks rise; quality wins

Market recap

The fourth quarter (Q4) of 2025 reinforced a late-cycle macro regime across the Eurozone, United Kingdom, and United States, disinflation continued, growth remained subdued, and central banks leaned cautious as they balanced improved inflation trends against still fragile domestic demand and policy uncertainty.

In the Eurozone, the European Central Bank (ECB) maintained a steady stance, leaving the deposit facility rate unchanged at 2.00% at its December 18 meeting. Inflation moved back to target, with Eurostat’s flash estimate putting December 2025 euro area inflation at 2.00% year over year. Growth remained soft and uneven, with services outperforming manufacturing, keeping front-end rates anchored and supportive of a carry-focused cash environment, while political and external risks sustained a premium on liquidity and diversification.

In the United Kingdom, the Bank of England (BoE) continued its gradual easing bias, cutting Bank Rate to 3.75% at the meeting, ending December 17 with consumer price index (CPI) inflation noted at 3.20%, still above target but easing. The macro picture remained mixed, activity was modest and confidence uneven, while labour market cooling improved the medium-term inflation outlook, reinforcing expectations for a measured path into 2026.

In the United States, the Federal Reserve (Fed) lowered the target range to 3.50% to 3.75% on December 10, signalling continued normalisation while retaining data dependence. The quarter’s data signal was complicated by a 43-day federal government shutdown that disrupted key releases, including the absence of a full October CPI, and delayed personal consumption expenditures (PCE) inflation reporting, increasing uncertainty around the near-term trajectory even as inflation moderated, with November CPI at 2.70% year over year.

Across EUR, GBP, and USD, money market funds remained a resilient allocation, offering liquidity and attractive income, with Q4 reinforcing the value of maturity discipline.

European market overview:

In the fourth quarter of 2025, the Eurozone macro backdrop remained one of cautious stability, with policy, growth, and inflation dynamics largely consistent with a prolonged “pause” environment. Headline inflation stayed broadly close to the European Central Bank’s objective, while core inflation continued to edge lower, albeit gradually, reflecting the slow normalisation of services inflation and wage pass through. As highlighted in Chart 2, inflation printed within a relatively narrow range through the quarter, which helped contain front end volatility and supported a more predictable carry environment.

Against this backdrop, the ECB maintained policy settings and reiterated a data-dependent approach, keeping a close watch on services inflation, wage dynamics, and the evolving external environment. The front end remained anchored by the ECB’s steady stance, while market pricing continued to oscillate around the timing and scale of any eventual easing in 2026. Directionally, the balance of risk was shaped by three familiar themes, global trade frictions, energy price sensitivity, and domestic political developments across key member states. This combination reinforced a regime where the market’s “terminal” policy debate mattered less than the question of how long restrictive settings would be maintained.

Activity remained soft but did not materially deteriorate. Incoming data suggested modest expansion, supported by improved real income dynamics and easing financial conditions relative to earlier in the year, but constrained by weak manufacturing momentum and uneven external demand. Survey indicators remained consistent with near-trend growth, with services continuing to outperform manufacturing, as indicated in Chart 3 and Chart 4. The result was a growth profile that felt stable but uninspiring, sufficient to sustain risk appetite intermittently, but not strong enough to force a hawkish repricing at the front end.

Labour market conditions stayed resilient, though the pace of job creation softened. Wage growth showed early signs of cooling, which supported confidence that domestic inflation pressures would continue to moderate into 2026. From a front-end perspective, this reduced the probability of renewed tightening, while still leaving the ECB with justification to remain cautious until disinflation was clearly entrenched.

The fourth quarter of 2025 was defined by a continued balancing act for the Bank of England, as the UK economy navigated a mixed growth picture and an inflation profile that remained sensitive to domestic cost drivers. Policy communications stayed cautious, with the Monetary Policy Committee emphasising gradualism and data dependence, reflecting the need to confirm that services inflation and wage growth were cooling sustainably before moving decisively toward easing.

Inflation moderated from earlier peaks but remained uneven through the quarter, at times holding above target and keeping the market focused on labour costs, services pricing, and regulated price adjustments. As shown in Chart 5, the inflation path supported a cautious policy stance, limiting the extent to which investors could bring forward expectations of rapid rate cuts.

Activity data suggested a modest and uneven expansion. GDP growth remained subdued, and business sentiment oscillated around neutral levels, consistent with a private sector that was neither contracting sharply nor accelerating meaningfully, as indicated in Chart 6 and Chart 7. This “low growth, improving inflation” mix kept the front end highly sensitive to incremental data, especially labour market prints and measures of services inflation momentum.

Labour market conditions softened at the margin. Hiring intentions eased, vacancy trends continued to normalise, and wage growth showed signs of deceleration. For the rates market, this was important because wage moderation acts as the bridge between restrictive policy and lower services inflation, strengthening the case that inflation pressures could fade further into 2026.

Fiscal developments remained a key input for sterling markets. Policy announcements late in the year influenced expectations for gilt supply and the broader growth outlook, with knock-on effects for front end term premia and liquidity conditions. For cash investors, the interaction between fiscal signalling, issuance expectations, and policy pricing remained a recurring driver of short dated yield dispersion.

In the fourth quarter of 2025, the U.S. policy narrative shifted further toward normalisation as evidence accumulated that labour market conditions were cooling and inflation was trending lower, albeit unevenly. 

Following the initial easing step in September, the Federal Reserve delivered additional accommodation through year-end, bringing the target range to 3.50% to 3.75% as of 31 December 2025, as reflected in Chart 10.

A 43-day federal government shutdown ran from October 1, 2025, through November 12, 2025, forcing broad suspensions of data collection and publication across agencies.

Disinflation progressed, but the data signal became more difficult to interpret because the federal statistical system suffered a material disruption during the quarter.

Inflation, directionally lower, but with an important gap. Annual CPI inflation printed at 2.70% year over year in November, down from 3.00% in September, reinforcing the narrative of easing price pressures. Data continuity was impaired. The Bureau of Labor Statistics (BLS) cancelled the October CPI report because the shutdown halted CPI data collection, making a full October print infeasible.

PCE inflation was also affected. With the October CPI missing, the Bureau of Economic Analysis (BEA) indicated it would use an average of September and November CPI data to estimate October inflation inputs for PCE, and it delayed the October and November PCE inflation data release to January 22, 2026.

Labour market readings were incomplete. The shutdown led to the cancellation of the October employment report, with BLS indicating October payrolls would be released alongside November employment data, while the October unemployment rate, derived from the household survey, would remain unknown.

The key market question was not whether the Fed had started to ease, but rather how quickly it would proceed in 2026, and how long policy would remain restrictive in real terms.

Source: Refinitiv Datastream and Bloomberg. Chart by BlackRock Investment Institute as of December 31st, 2025. CPI , Unemployment Rate and PCE as of November 2025. This chart does not reflect back-dated data revisions from the Bureau of Labor Statistics. For abbreviated terms and definitions, please refer to the pages titled “Definitions.”

 Policy communications remained centred on risk management. The FOMC highlighted that labour market conditions had loosened compared with earlier in the year, while reiterating that inflation was still somewhat elevated and progress back to 2.00% was not assured. Incoming inflation and employment data, shown in Chart 9, kept markets sensitive to each incremental data release and to shifts in the Fed’s confidence about the disinflation trajectory.

Source: Refinitiv Datastream, Bloomberg. Chart by BlackRock Investment Institute as of December 31, 2025, and depicts the latest Summary of Economic Projections by the Federal Reserve dated December 10, 2025. There is no guarantee projections will be realized. Actual upper range line represents the upper limit to the Federal Funds Target ranges. As of December 31, 2025, the target range was 3.50% to 3.75%. The upper range would be 3.75%.