Economic and financial risk insights: Policy uncertainty fuels growth and inflation worries

• Growth: we have placed our forecast for US growth under review as trade uncertainties slow economic momentum. In contrast we plan to review our euro area and China growth forecasts upward on new fiscal initiatives.
• Inflation: in similar vein, the breadth of tariff proposals adds upside risks to our US inflation forecast for 2025. Conversely, we expect inflation in the euro area to trend at around the 2% ECB target this year.
• Interest rates: the Fed will be patient in further policy easing, but we continue to expect two rate cuts later this year. With new fiscal loosening in Germany and the EU, we now see greater odds for fewer ECB rate cuts.

Forecasts under review as significant policy changes raise downside risks in the US, but upside risks in Europe and China. We are re-assessing our US growth forecast with policy and trade uncertainty being at an all-time high (see Figure 1). The impacts already show in macro data and add significant downside risk to our US 1Q25 and full-year growth forecasts.

Figure 1: US policy uncertainty  

Even if tariffs proposals do not materialise fully, uncertainty is weighing on consumer and business sentiment, with the re-inversion of the yield curve pointing growth worries. The US labour market added 151 000 jobs in February, but other indicators point to slowdown. The goods deficit rose to a record high in January as businesses front-ran tariff increases by upping imports (see Figure 2). Consumption momentum is slowing, with real spending down 0.5% in January. A US government shutdown this week, if such happens, would add further downside risk.

Figure 2: US goods trade deficit  

Figure 3: US non-farm payrolls

In contrast, in the euro area recent developments introduce upside risks to our mid-term growth forecasts. Namely, the surprise announcement in Germany of €500 billion in new infrastructure spend and adjustments to the debt brake (subject to parliamentary approval) and also plans to loosen EU fiscal rules for defense spending. In China, the unveiling of a 5% growth target and a historical high fiscal deficit of 4% lend upside risks to growth.

Trade risks trigger review of US inflation outlook. The prospect of aggressive tariff hikes adds upside risk to the US inflation outlook. This even with a resumption of disinflation in the US and Europe. The Federal Reserve's (Fed) preferred inflation gauge provided a reassuring signal in January (see Figure 4), with headline PCE inflation easing 10bps to 2.5%. Core PCE inflation fell 20bps to 2.6%. In the euro area, inflation edged lower with core prices easing to 2.6% in February from around 2.7%. Meanwhile in China, as deflationary forces persist, the government has lowered the longstanding 3% inflation target to 2%.

Figure 4: US PCE and euro area HICP

Central banks increasingly policy dependent. Recent softness in US data complicates the Fed’s policy path when combined with erratic policy announcements. We see rates holding steady this month (see Figure 5) to allow time for policy developments to unfold. The European Central Bank (ECB) cut the deposit rate to 2.5% last week, signalling that policy is nearing its neutral rate of 2%. Given Europe's recently announced fiscal shifts, we now expect fewer rate cuts and will be revising our year-end policy rate forecast higher next month, along with our 10-year Bund yield assumptions on the back of greater bond issuance (see Figure 6).

Figure 5: Monetary policy outlook

Figure 6: Government 10-year yields 

Our forecasts are under review as the escalation in tariffs add significant downside risk to the US growth and upside potential to the inflation outlook. In Europe and China, fiscal stimulus may boost growth.

Swiss Re Institute key forecasts for 2025 and 2026