World outlook: Global trade under pressure due to announced US tariffs

The past year saw moderate global economic growth. While the US again outperformed expectations in 2024, this was largely offset by weakness in other advanced economies, especially in larger European countries and ongoing economic headwinds from China. We expect this economic expansion to continue in 2025, but at a modest pace.

After several years of crisis, cyclical imbalances have decreased since the beginning of 2024, leading to a better balance between supply and demand. This normalization has helped global inflation to fall, and inflation rates in different countries have become more aligned. While this is a positive development, it does not mean that inflation is no longer a problem. Economists typically examine inflation over the past year, but in 2024 the electoral defeats of incumbent political parties in various countries are attributed to the overall price increases over the past three years. Policymakers and politicians have found that voters have an even greater aversion to price increases than previously thought.

Improved labor market balances (see figures 3 and 4) and gradually declining inflation have given central banks the opportunity to cut policy rates. At the time of writing, both the Federal Reserve and the ECB have cut their base rates by a total of 100 basis points. Both the European and US economies have weathered previous rate hikes reasonably well. Without the political turmoil in Europe, such as the fall of the German and French governments, and Trump's convincing victory in the US presidential elections, central banks would be close to their original goal of a "soft landing.”

However, the prospects for further interest rate cuts in 2025 are uncertain. We believe that the growth and inflation outlook for 2025 and beyond will heavily depend on the economic policies of the Trump administration and the responses from other economic blocs, particularly China and the European Union.

Donald Trump's return to the White House, with Republican majorities in both the Senate and House of Representatives, is leading to a major shift in US economic policy, with global effects. Trump's new team seems better prepared than in 2016 and can rely on stronger representation from the MAGA (Make America Great Again) movement in Congress. As a result, the usual Republican agenda of tax cuts, deregulation and high defense spending coincides with Trump's preference for trade tariffs.

During his campaign, Trump repeatedly mentioned a universal import tariff of 10% to 20% and an additional tariff of possibly 60% on Chinese imports. In late November, Trump took the first step with a warning that he would impose additional tariffs on Canada, Mexico, and China. He links these levies not to economic policy, but to the "invasion" of drugs, especially fentanyl, and migrants in the case of Canada and Mexico. Until this is resolved, according to Trump, American importers must pay an additional 25% duty on Canadian and Mexican products and 10% on Chinese products. Trump has promised to sign a presidential decree putting this measure into effect on January 20. He has also already threatened tariffs of 100% on products from BRICS countries (Brazil, Russia, India, China, and South Africa) unless they promise not to start a new currency or promote one of their own (read: the Chinese yuan) as a reserve currency.

We don't expect it to stop there, and we believe Trump will continue to issue threats toward China and also target the European Union. Given that the incoming president uses tariffs as a bargaining tool, we take Trump's tariff threats seriously, although not literally. Earlier in 2024, we factored an increase in US import tariffs in our baseline projections and expanded on this outlook later in the year. Our model simulations indicate that these would lead to a resurgence of inflation in the US and a slowdown in real income growth. Depending on what retaliatory measures other countries take, they also lead to higher inflation and/or lower growth elsewhere. We previously discussed (in Dutch) the implications for the Dutch economy.

The role of treasury secretary is particularly interesting. This post has been assigned to hedge fund manager Scott Bessent, who is seen as a stabilizing and Wall Street-friendly figure on Trump’s team. Bessent may be able to soften the sharpest edges off the administration’s policy. His “3-3-3 agenda,” is inspired by the three arrows of ”Abenomics” – a policy advocated by former Japanese Prime Minister Abe. This agenda aims for 3% economic growth through tax cuts and deregulation, 3% government deficit through cuts in federal spending, and an increase in US oil production by three million barrels per day.

Although the US government is relying on deregulation to boost oil production and lower energy costs (and thus inflation), this is easier said than done. Production is equally dependent on global supply and demand dynamics. US oil production must also adjust to declining growth in fossil fuel demand. We estimate that the incoming Trump administration will have less impact on many energy markets than his catchphrase "Drill, baby, drill" suggests. Unless the US government decides to subsidize production or drill its own wells, global economic factors will still determine oil and gas production.

Under normal circumstances, we would expect the US economy to lose growth momentum due to tariffs. Consumers have less financial room for spending and the labor market is gradually cooling. Countering this agenda may include extending the Tax Cuts and Jobs Act of 2017. This will make it difficult to reduce the budget deficit, which is already inflated to 6% to 7%. The potential of import tariffs as a major revenue source for the government is limited, while there is little room for substantial spending cuts without hitting large groups of voters.

We have revised our growth expectations slightly upward. After about 2.5% growth in 2024, we expect the US economy to grow about 2% in 2025. A recession no longer seems plausible in 2025, but growth is still expected to fall to 1.2% in 2026, partly due to the impact of import tariffs. Inflation is likely to remain above the Federal Reserve's 2% target due to the combination of tariffs and tax cuts. We expect inflation to average 3.1% in 2025 and about 4% in 2026. This limits the scope for the Fed to cut interest rates further. After the most recent December cut, we expect only one more rate cut of 25 basis points, bringing the (upper bound) rate to 4.25%.

We expect that China is likely to react firmly to US tariffs. In recent years, it has already shifted some of its most sensitive US imports to those from other suppliers, such as Brazil, particularly for products such as soybeans. For President Xi, it is important to show that China operates from a position of strength: Economic policy in China is determined by the Party, not the US. China also wants to demonstrate that it can operate independently of the US "ecosystem" when necessary. However, there is overcapacity in many industries and this production needs to be sold somewhere. If China really comes under pressure from US policy and cannot easily sell its production in the rest of the world, it might decide to unleash a significant domestic demand stimulus.

China's economy has underperformed in recent years, largely due to persistent problems in the real estate sector. Since September, Chinese policymakers have announced a series of measures to stimulate growth. The package of measures is comprehensive, but predominantly focused on increasing output, which we believe is insufficient to ensure a strong and sustained recovery in domestic demand. Therefore, we still estimate growth of 4.7% for 2025, slightly below China's official target. If future stimulus measures focus more on supporting consumption rather than production, we may revise our growth forecast upward.

Europe continues to seek its own role in the tension between China and the US. There are opportunities: If the US imposes additional tariffs on Chinese goods, European exporters can try to take advantage of them, assuming American producers cannot meet the full demand. However, if China redirects its excess capacity to Europe or on markets where European companies operate, pressure increases on Brussels to follow the US line. This risk is greater in the production of goods that Europe considers essential to its industrial development, such as electric cars.

A universal US import tariff poses a serious problem for Europe, especially since retaliatory measures would hurt Europe itself. At best, as in 2018, Europe could respond partially, selectively, and with some delay. It is likely that Europe will first engage in negotiations to reduce or avoid tariffs, for example, through large purchases of LNG and defense equipment. In 2018, former European Commission President Jean-Claude Juncker managed to dissuade Trump from imposing tariffs on European cars by promising that Europe would buy more US soybeans and LNG. Although Juncker did not have the power to actually make this happen, this trend was already underway, and he was able to present Trump with a sweet deal.

The negative impact of tariffs on exports to the US, persistently high energy prices, and a potential political vacuum in central Europe –due to German elections in February 2025 and a possibly even more unstable political situation in France– could create a negative feedback loop. This could lead to job losses, the increased pace of moving uncompetitive production out of the eurozone, and ultimately spread weakness from the industrial sector to the service sector. While we have not reached this point yet, the meager results from the latest purchasing managers' index show that this is represent a concrete risk.

Europe's growing competitiveness gap with its major trading partners is largely structural and requires major reforms: less bureaucracy, a more accessible capital market, and substantial increases in public and private investment. European Commission President Von der Leyen, with good reason, aims to quickly turn the recommendations of the Draghi report on European competitiveness into concrete proposals. In late November, she announced the "competitiveness compass" to close the innovation gap with the US and China, increase security, and ensure CO2 reduction. We expect that "Trump 2.0" will accelerate decisions intended to strengthen Europe's strategic autonomy. However, the political landscape in Europe is challenging, to say the least.

Economic outlook for Europe

Uncertainty and structural growth concerns are still likely to continue weighing on investment growth in 2025, even though conditions of credit markets have improved and short-term interest rates are set to fall by at least another 75 basis points in 2025. However, European households are finally in a better position to spend. Wage growth has outpaced inflation for some time, boosting consumer confidence in many European countries and potentially reducing the need to save. Conditions for taking out credit to purchase large items have also improved. We expect the eurozone economy to grow by 1.1% in 2025, mainly due to an increase in household consumption of about 1.5%. This would represent an acceleration from 2024, where growth is expected to be 0.9%. For 2026, we also estimate growth of 1.1% (below trend), mainly due to expected import tariffs and the need for austerity in several large member states, especially those that have already received warnings from the European Commission earlier in 2024.

Despite the relatively low growth potential of the eurozone economy, it is difficult to argue that demand is "strong," let alone that the economy is overheating. However, we expect inflation to remain high and somewhat persistent over the next two years. This is largely due to "supply" factors such as tariffs, rather than strong demand. Commodity price inflation has not been a significant issue for two years. After substantial price increases in 2022 and 2023, the situation has now stabilized. Nevertheless, steps to strengthen strategic autonomy (defense, energy transition) may still lead to renewed acceleration. Meanwhile, we continue to see inflationary pressure in the prices of services. There has been little progress in this area, although the last few months seem to be slightly better. The labor market remains tight, with workers and employers trying to pass on the real income loss from the 2022 price shock to each other. We expect inflation to remain slightly above the ECB's target, at 2.2% in 2025, and 2.3% in 2026, but still lower than in the US.

Forecasts

We have adjusted our ECB policy rate forecast. For 2025, we have included an additional interest rate cut in the first half of the year. We expect three interest rate cuts, which would bring the deposit rate to 2.25% next summer. This is still more than 0.5 percentage points higher than what the financial markets are currently anticipating.

The ECB must navigate an environment of rapidly changing conditions. In recent months, much attention has been focused on structural problems in European (particularly German) industry and political instability in Germany and France. This has somewhat distracted attention from ongoing service inflation, leading market participants to price in more interest rate cuts. The reasoning is that inflation naturally declines as economic demand decreases.

While we partly agree with this, there are also positive signs for domestic demand, as discussed above. The terms-of-trade loss from the 2021-2022 energy crisis has turned into a terms-of-trade gain since 2023, and the positive effects have not yet worn off. If job losses in the eurozone (and their impact on consumption) during 2025 become more pronounced than we currently anticipate, the ECB may be willing to turn a blind eye to continued services inflation. Otherwise, the many uncertainties call for a cautious stance.

One of these uncertainties is the "neutral" interest rate, the theoretical level at which the economy moves toward its potential growth and inflation target over time. ECB Executive Board member Isabel Schnabel recently noted in a Bloomberg interview that she believes the neutral level is around 1.75%, but she would not consider it prudent to lower interest rates below that level in 2025. Based on this, you can conclude that from a market perspective, there is not much room downward, unless the economic picture changes sharply.

In the eurozone, the decline in capital market interest rates has continued in recent months. This involved a "level" shift of the curve, with both short-term and long-term interest rates falling. The market now anticipates more central bank interest rate cuts than before. The ECB is expected to cut policy rates to well below 2% in 2025, with limited potential for rate hikes thereafter. This has led to a significant drop in swap rates. The 5-year swap is currently just above 2%, 20 basis points above its lowest level since August 2022. The 10-year swap is also close to its lowest level in more than two years at 2.3%.

While we recognize that Europe is under pressure, we think this decline is too steep (and we have already seen some correction in recent weeks). The market views the protectionist policies of the US as especially detrimental to Europe because they lead to less economic growth. However, we believe these policies also cause inflation in Europe, especially if the EU retaliates. Also, if European companies move production facilities to the US to circumvent tariffs, production capacity in Europe decreases. The upward inflationary effects of this come from the supply side and could push inflation expectations back up even as they depress growth. We expect to see this inflation risk premium more clearly reflected in interest rates.

Moreover, American protectionism adds urgency to the major challenges facing Europe, such as climate, energy, supply chains, and defense. These challengens require significant investments. Will the new German government indeed agree to relax strict budget rules and invest more in its industry and defense? All this, in our view, puts a floor under inflation around the ECB target, which previously acted as a ceiling. We therefore see room for a modest rise in capital market rates over the next 12 months. That would result in a slightly positive slope of the yield curve (see table 2).

Since the US elections, currency markets have become highly volatile, largely due to the rapid appreciation of the dollar. Although incoming President Trump aims for a weak dollar –meaning a stronger euro, yen, yuan, or peso– his trade policies are actually leading to a stronger dollar. We have already discussed these effects in the box above.

An additional factor for the eurozone is the deteriorating political situation in Europe. The German and French governments both fell due to budget disputes. At best, the German election result could lead to changes in both domestic and European fiscal policy. Chancellor candidate Merz is not ruling out debt brake reforms, but it is uncertain whether he will find sufficient support.

There are also fears in the market that the German economy will suffer significantly from the Trump tariffs. This is further exacerbated by expectations that Germany will need more time to adjust to the loss of cheap Russian energy and the changing trade relationship with China. In this context, German exporters would almost certainly welcome a weaker euro, reinforcing calls for the ECB not to be too tough on inflation. We have therefore lowered our EUR/USD forecasts and expect a move to parity around the middle of 2025, along with the possible introduction of new US trade tariffs.

In contrast, the UK has a relatively favorable starting position, despite the disadvantages of protectionism for an open economy. Trade in goods between the UK and the US is balanced, while the UK has a significant surplus in services, thanks to its strong position in business services. Trump has shown little interest in services: It is impossible to impose an import tariff on an annual report, a legal advice, or a strategic plan. This offers the UK some protection from the economic turbulence of a global tariff battle. Combined with relatively high interest rates in the UK due to persistently high service sector inflation, we expect the pound to remain strong. We foresee a EUR/GBP exchange rate of 0.82 in the medium term.