The outlook is positive for M&A, says Jackie Bowie, but interest rates need to continue on a downward trajectory – and no more shocks please.
By the time you read this, Donald Trump will be nearly one month into his second presidency. His victory buoyed financial markets, partly because at least the outcome was decisive. We will now see whether they had more reason than that to be upbeat.
Last year was expected to be one of political upheaval in Europe and the US, and certainly delivered. After the inflationary environment of 2022 and 2023, and central banks’ increased interest rates, the market came into 2024 with very bullish forecasts of rate cuts: some 175 basis points (bps) for Fed Funds and 125bps for UK rates. A first cut of 50bps from the Fed in September was followed by just another 25bps a little before Christmas. Market expectations are for only a further 50bps in 2025.
What played out was continued pushback of both the timing and extent of these cuts. A key concern was that inflation was not quite under control and, for the UK, while the headline Consumer Price Index (CPI) hit target, underlying services level inflation remained high.
Inflationary concerns remain front and centre for the UK and the US. The Trump tariff is potentially inflationary, and the UK’s Office for Budget Responsibility has forecast that the Autumn Budget’s fiscal loosening and the expected pass through of employer NICs will push the CPI back above the Bank of England’s 2% target.
Looking at growth, UK forecasts remain lacklustre for 2025 and beyond; despite the Labour government’s spending largesse, there is no impact on the growth rate of the economy. Within a European context, though, the UK may be the bright spot while major EU economies struggle. Germany, for one, is facing structural recession.
In the US, the economy continues to show positive trends, consumer spending driving growth and GDP growth expected to come in at 2.7% for 2024. For now it looks like the Fed has achieved its soft landing.
So how will this impact interest rates? As it stands, the market is expecting that by the end of 2025 European interest rates will be just below 2%, UK rates around 4%, and US rates also just below 4%. In the UK as we start the year there is talk of interest rates actually rising. It is important to point out, however, that the market has been overestimating these rate cuts for the past 18 months.
The cost of borrowing has been the single key factor in determining transaction activity, or rather the lack of it: last year borrowers delayed refinancings, instead taking advantage of short-dated extensions in loan terms and working with lenders to restructure covenants. Investor sentiment has been cautious as valuations across all assets are questioned.
Dealmaking question
Global M&A activity began to decline in 2022, reflecting the shift in the interest rate environment. By the end of 2024 there were some early signs of recovery, but not across the board. Sectors undergoing some kind of transformation, or those deemed transformational for other industries, are the main beneficiaries – renewable energy, digitisation and AI.
For transactions in 2024, the UK has seen a larger-than-usual slice – recording its highest share of European dealmaking since 2015 according to BCG. Fundraising for PE sponsors has been relatively successful. Capital for new investments remains at around $2tn. With significant pent-up demand, and assuming no major economic negatives, 2025 bodes well for a year of stronger transaction activity.
Availability and sources of debt capital will be a trend to focus on. The growth in private credit lenders has structurally changed the financing markets. Their dry powder has grown at a 15% compound annual growth rate over the past 10 years. This source of debt can be more flexible, and is expected to drive renewed activity.
Valuation adjustments are underway, but there are still gaps between buyer and seller expectations, which remain an obstacle to any recovery in deals. This means more competition for the highest quality assets, and GPs looking for exits either through direct secondary transactions or continuation funds.
There is still plenty of optimism that 2025 will be a comeback year for M&A, but this is reliant on continued reduction in interest rates and no further major geopolitical shocks. With new leadership in the UK and the US, there is still a chance that the economic backdrop shifts from what is currently expected. Investors and dealmakers are eager to return to transaction activity, but should be prepared for the known unknowns.
Jackie Bowie, managing partner and head of EMEA at Chatham Financial, a member of the Corporate Finance Faculty