Economic and financial risk insights: ongoing tariff negotiations precede a global growth slowdown later this year

• Growth: US growth slowdown likely, prompting downward revisions to growth across regions. 
• Inflation: Tariffs will drive US inflation higher than in Europe and China, both insulated by strong currency appreciation. 
• Interest rates: The Fed will remain patient before two cuts later this year; the ECB will cut at least twice and possibly more to protect against downside growth risks. 

Momentum slowing sharply. In our updated US forecast, we now expect just 1.5% GDP growth in 2025 following a trade-distorted -0.3% Q1contraction (see Figure 1) and further consumption moderation in H225. The 90-day de-escalation in tariff rates between the US and China are encouraging, with volatile shipping volumes now rebounding in May after a weak April (Figure 2). Negotiations are currently ongoing, and future sectoral measures will leave the effective tariff rate at 15% under our baseline. Frontloading ahead of the global tariff shock was a tailwind to euro area growth. Exports (particularly from Ireland) supported a stronger-than-expected Q1 growth rate. Whilst trade negotiations will be key for the European outlook, we expect policy uncertainty to predominantly weigh on economic activity and now forecast GDP growth lower at 0.8% this year. Our updated outlook for China also includes a marginal tariff-induced headwind this year, leaving our GDP growth forecast at 4.7%.

Asymmetric inflation across regions. We expect higher tariffs will leave US inflation at an annual average of 3.0% this year, the same as in 2024. In contrast, tariffs will be disinflationary in other markets given sharp currency appreciations against the dollar (see Figure 3). In Europe, currency strength and dumping of consumption goods from Asia will determine the severity of trade-war disinflation (see Figure 4). Asian currency appreciation resulting from capital repatriation and eroded faith in US dollar assets will be a modest headwind to export-driven economies, but we expect China's steady CNY/USD rate fixing to be a stabilising anchor for other currencies.

Fed finds itself back on defence. Higher tariffs will slow progress towards the Fed's dual inflation-unemployment mandate (see Figure 5). We expect the Fed to deliver two rate cuts in H225, in line with the latest market pricing. In Europe, we expect the ECB will cut two further times to bring the policy rate to 1.75% by year end as disinflation risks become apparent and weak growth conditions prolong. Inflation concerns in the UK will lead the BoE to gradually loosen rates. In China, the PBOC announced multiple easing measures including 10bps policy rate cut, 50bps RRR cut, and a CNY 500bn relending facility – we see room for further easing to mitigate impact of US tariffs. We expect US sovereign bond yields to settle lower at 4.2% by year-end as markets price in the second half growth slowdown. However, risks are to the upside if US fiscal policy changes by year-end fuel a sharper rise in the term premium.

Table: Key forecasts and scenarios (in %)

Figure 1: US GDP growth

Figure 2: US-China container ship tonnage

Figure 3: Currency appreciation

Figure 4: Euro area trade with US and China 

Figure 5: US inflation and unemployment rate

Figure 6: SRI interest rate projections

Risks that could significantly shift our baseline outlook.

Alongside the 90-day China tariff pause the US is negotiating trade deals with other countries. However, a failure to achieve tariff/trade deals will threaten a sharp economic downturn not currently reflected in market pricing. US bond yields remain elevated relative to earlier in the year. The US dollar is 5% weaker than at the beginning of the year as investors increasingly shift into alternative safe havens such as gold and the Swiss franc. More downside risk is likely if current tariff negotiations falter. Strained funding markets could disrupt liquidity and credit availability, amplifying systemic risks that may force Fed intervention if tariff negotiations do not develop positively.

A failure to successfully negotiate lower tariffs could see a trade war escalation. While a "hot" war is not expected, new country/sector/company sanctions could force states to choose between trade with the US or China. Global conflicts – most recently between India and Pakistan – are further destabilising factors. The "ReArm Europe" plan, worth up to EUR 800 billion, will bolster the EU's strategic autonomy. China's restated commitment to "firmly advance" reunification with Taiwan and its omission of the term "peaceful" raise regional security concerns.

The US fiscal trajectory will likely worsen if trade war triggers a recession. The Department of Government Efficiency's spending cuts will not alleviate structural deficit pressures as mandatory outlays and net interest expenses continue to rise. Recent tax proposals would see further unfunded revenue reductions. A full Tax Cuts and Job Act (TCJA) extension alone would add up to USD 4.6 trillion to the US deficit through 2033. Germany's debt brake reform and EUR 500 billion infrastructure fund will shift the country towards a potentially worse debt outlook. The UK and France also face fiscal concerns.

Stricter US immigration policies may dampen future labour supply growth, tightening labour markets and leading to wage growth. However, the latter could be moderated if demand for labour contracts significantly under a recession. Volatile and lagging labour market data continues to complicate policy making.

Erratic and unpredictable  US policy changes may trigger  economic stability concerns and cause financial market volatility. This could culminate in a loss of trust in the US dollar and risk-free treasuries. In Europe, policy uncertainty and social discontent remain key risks. Germany's new government has experienced a rocky start, potentially hindering policy effectiveness, while the Alternative for Germany (AfD), now the second largest party in the Bundestag, continues to accentuate political polarisation.

Uncertainty over US fiscal and trade policy, alongside their inflationary implications, complicates the job of central bankers in maintaining price stability without triggering a downturn. Despite upside price risks, the bar for the Fed to hike interest rates remains high. In Europe, measured and predictable quantitative tightening is contributing to money market normalisation but sudden shifts in government bond transactions could add long-term risk-free rates volatility, especially if combined with government bond supply shocks.

Global economic growth could be boosted by a US tariff policy u-turn; productivity improvements driven by sustained technological progress (especially in artificial intelligence); higher fiscal spending; a resolution of military conflicts in Ukraine and the Middle East; and a rebound of activity in China. The new German government is expected to implement significant fiscal stimulus following its reform of the debt brake. Coupled with defence spending increases across the continent, these measures could bolster domestic demand and have positive spillover effects for European growth.