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Global economy to weather geopolitical headwinds

Global Economic Outlook
Q3 2025

Global GDP growth will slow in the next two years, as Trump’s policies weigh on US activity and fiscal policy proves less supportive of growth in China.
Jennifer McKeown
Jennifer McKeown
Chief Global Economist

These are the key takeaways from our Q2 2025 Global Economic Outlook, originally published on 30th June, 2025. Some forecasts contained within may have been changed since publication. Access to the complete report, including extensive forecasts, near to long-term analysis and interactive data resources, is available as part of our subscription services.

  • Global GDP growth is set to slow over the next two years, with Trump’s policies dampening US activity and China's fiscal boost waning. India will remain a strong performer, with growth averaging 7% through 2025. As inflation continues to ease, most central banks will press ahead with rate cuts — though a tariff-driven pickup in US core goods inflation will likely keep the Fed on hold for the rest of the year.
  • Our baseline forecast is for tariffs to remain at their current levels of around 10% on most countries and 40% on China, causing the US effective tariff rate to rise close to 15%. (See Chart 1.) As long as retaliation by other countries is limited, we expect this to only knock about 0.3% off global GDP by end-2026. So global GDP growth will slow to a touch below 3% in the next two years. (See Chart 2.)

Chart 1: US Effective Tariff Rate (%)

Chart 2: Global GDP (% y/y)

  • While some economies experienced an initial boost from tariff front-running in Q1, this has already unwound. And we expect tariffs to reduce global real goods trade by about 1% over the next two years. (See Chart 3.) While China’s direct exports to the US will fall sharply, its ability to reroute most of its exports will lessen the overall hit to global trade.
  • Although tariffs appear to have had a negligible impact on US activity and price pressures so far, we expect tariffs and immigration curbs to weigh on US GDP growth over the next few quarters. Meanwhile, looser fiscal policy will provide a prop to growth in Germany, but not enough to provide a meaningful boost to growth at the euro-zone level. Nonetheless, the relatively limited impact of tariffs in most non-US DMs (apart from Canada) means that the US economy’s outperformance will come to an end. (See Chart 4.)

Chart 3: Global Real Goods Trade (% y/y)

Chart 4: US & Other DM GDP (% q/q annualised)

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  • In China, although official GDP figures show growth around the 5% target, activity as measured by our China Activity Proxy (CAP) has slowed sharply. (See Chart 5.) We think growth will fall further to 3.5% this year. After all, tariffs are just one of the headwinds facing exporters. And we continue to doubt that fiscal policies will do much to lift domestic demand.
  • Among other EMs, we are particularly optimistic about India’s growth prospects. The economy got off to a strong start in Q1, and while India faces some headwinds from tighter fiscal policy, it is relatively sheltered from US tariffs. Our growth forecasts also lie above the consensus in Asia and MENA, but below the consensus in Russia and Latin America.
  • Headline inflation is close to targets in many DMs. And while core inflation remains elevated in some cases, especially in the UK, a further cooling in labour markets should weigh on price pressures before long. The US is the exception, where we expect tariffs to cause core PCE inflation to rise to a little over 3% later this year. (See Chart 6.)

Chart 5: CE China Activity Proxy & Official GDP (% y/y)

Chart 6: Headline CPI Inflation (%)

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  • A key upside risk to inflation is if the Israel-Iran conflict were to intensify again, causing oil prices to rise to and remain at $100 or higher. In that case, DM headline inflation would be about 1%-pt higher this year. (See Chart 7.) But with the US-brokered ceasefire holding up for now, this risk has receded somewhat.
  • So with inflation more contained, most central banks will press on with rate cuts in the coming quarters. While we have probably passed the peak of the global policy loosening cycle, we think that a majority of central banks will still be cutting rates in the second half of this year. (See Chart 8.) But we still expect the Fed to refrain from rate cuts until early 2026.

Chart 7: Oil Price & DM Energy Inflation (% y/y)

Chart 8: Number of Rate Cuts/Hikes by Major Central Banks

Sources: USITC, LSEG, CEIC, Trade Hub, CE

These are takeaways from a 34-page report written for Capital Economics clients by Jennifer McKeown and the senior economist team, originally published on 30th June, 2025. ​The full report provides extensive near- to long-term economic forecasts as well as country, regional and markets analysis, including:

US – We expect tariffs to have only a modest impact on economic activity, with GDP growth slowing to 1.5% annualised and core PCE inflation rebounding to a little over 3% later this year. But the lingering threat of a more persistent pick-up in price pressures will prevent the Fed from cutting interest rates until next year.  

Euro-zone – Despite a boost from looser fiscal policy in Germany next year, we expect overall euro-zone GDP growth to remain sluggish. Inflation should stay around target, and the ECB is near the end of its easing cycle.

Japan – With inflation on track to overshoot the BoJ’s forecast, we expect the Bank to resume its tightening cycle before year-end despite GDP growth softening, and eventually hike rates to 1.5% in 2027.

UK – We expect inflation to fall to 2% next year as the weakening in the labour market feeds through to lower wage growth. As a result, we now think the BoE will cut interest rates all the way to 3%.

Canada – We expect US tariffs and trade policy uncertainty to weigh on GDP growth.

Australia & New Zealand – Easing price pressures mean the RBA and RBNZ will cut by more than most expect.  

China – The combination of less fiscal support, US tariffs, a fading prop from currency depreciation and property sector weakness will cause GDP growth to slow from nearly 5% last year to 3.5% in 2025 and 3% in 2026.

India – With the economy poised to grow at a 7% rate in the next two years, India will be a global outperformer. 

Other Asia – Below-trend GDP growth and below-target inflation will allow central banks to cut rates further.

Emerging Europe – GDP growth will pick up across most of the region, but slow in Russia and Turkey. 

Latin America – Deteriorating terms of trade and tighter fiscal policy will weigh on GDP growth across the region, while Mexico will face a further headwind from weaker US demand for its exports.

Middle East & North Africa – Lower oil prices and tighter fiscal policies will weigh on GDP growth across the region. But the Iran-Israel ceasefire has removed an immediate downside risk to the Gulf economies’ outlook.

Sub-Saharan Africa – GDP growth should pick up slightly across the region, but debt concerns will linger.  

Commodities – We expect most commodity prices, particularly oil, to fall over the next two years as supply rises. But tariffs complicate the outlook for metals markets and pose upside risks to prices in the near term.

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