Economic and financial risk insights: global economy remains in limbo pending clarity on US trade policy
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Key takeaways
- Growth: US slowdown to become more prominent in the coming months, while momentum in Europe and China remains subdued.
- Inflation: Near-term US disinflation to be replaced by higher goods prices in 3Q25; elsewhere deflation risks mount.
- Interest rates: Monetary policy divergence widens. Fed in wait-and-see mode; ECB and PBoC accommodate.
Growth
US slowdown to become more apparent in 3Q25. The divergence in US hard and soft data continues in 2Q, more so than in the euro area (see Figure 1). Household and corporate sentiment numbers are weak but nevertheless, the US economy added 139 000 jobs in May and employment measures reaffirm a balanced labour market (see Figure 2).
Figure 1: US and euro area data divergence
Figure 2: US labour market tightness indicators
The final shape of the House Reconciliation bill remains uncertain. While we expect it to pass later this summer, any growth impetus will be offset by the drag from higher tariffs and policy uncertainty in 2H25 when GDP growth falls below trend after a trade-supported rebound in 2Q25. The euro area grew by 0.6% in 1Q25, but we see subdued growth in 2Q25 and 3Q25 given elevated trade policy uncertainty and while export front-loading ahead of US tariffs fades (see Figure 3). China’s growth momentum remains largely stable with export growth holding up. A decline with the US was offset by stronger export growth with ASEAN.
Figure 3: Euro area goods trade flows with key partners (SA, 3-months moving average)
Inflation
Tariff pressures mount in the US; elsewhere deflation risks linger. Disinflation remains the dominant theme in 2Q25 though cross-region divergence will likely widen further in the coming months. US CPI remained muted at 2.4% year-on-year in May, but core goods inflation rose out of deflation to 0.3% year-on-year, its highest level since August 2023 (see Figure 4).
Figure 4: US core inflation measures
Euro area headline inflation fell below target to 1.9% in May, with core estimated near 2.3%. A near-10% trade-weighted euro gain since March is feeding through to import prices. Switzerland and the UK show similar currency-led price softness (see Figure 5). In China, CPI fell 0.1% y/y as households continue to deleverage. Producer prices fell 2.7% y/y in April amid weak domestic demand, falling global commodity prices and excess industrial capacity.
Figure 5: European currency moves, per USD
Interest rates
In the US, still waiting for Godot. Ongoing trade policy uncertainty and recent commentary reaffirms a continued wait-and-see Federal Reserve stance before a next rate move. We expect two rate cuts before the end the year. Market pricing of future these cuts supports our year-end 10-year yield forecast of 4.2%, but rate divergence (see Figure 6) is likely to continue as the deteriorating fiscal outlook keeps long-term US bond yields disjointed from Fed policy. In Europe, the European Central Bank (ECB) cut the deposit rate by 25 bp to 2.0% in May. Bund yields have eased to 2.6% as investors price in further disinflation and policy easing. The People's Bank of China (PBoC) followed its mid-May 50 bp RRR cut with larger-than-usual liquidity injections to steady funding costs.
Figure 6: US 10-year yield divergence from US policy rate
Baseline view
US growth slowdown set to intensify in the second half of this year driven be weaker consumer spending. Inflation risks remain elevated in the US, while Europe and China will feel deflationary pressures. US policy rates will remain restrictive relative to Europe.
Table 1: Key forecasts and scenarios