New economic scenario: The world holds its breath over Trump’s tariffs

The months since our previous revision of the international economic-financial scenario have been particularly intense on both sides of the Atlantic. In Europe, in mid-March, Germany shifted its traditional policy of fiscal austerity, modifying its constitution to «soften» the debt brake introduced in 2009 and approving an infrastructure plan for the next 12 years valued at 500 billion euros. Around the same time, obliged by the new Trump administration’s position regarding its role in NATO, the European Commission presented the Rearm Europe plan, which included a package of measures worth 800 billion euros aimed at boosting defence spending over the next four years and which is awaiting approval at the European Council meeting in late June.

However, the world economy was shaken on 2 April by so-called Liberation Day, when Trump announced a universal tariff of 10% and imposed additional protectionist measures on a series of countries in the form of mislabelled «reciprocal» tariffs. The strong reaction of the markets to these plans (falls in the stock markets, a spike in Treasury yields and the depreciation of the dollar) led Trump, just a week later, to postpone the introduction of the toughest measures for 90 days. Nevertheless, this truce has coexisted for several weeks with an unprecedented escalation with China that has brought the effective average tariff applied by the US to around 15%, compared to 2.5% in 2024 (see the Focus «US tariffs: where do we stand and what comes next?» in this same Monthly Report).

In our revision of the international forecast scenario, we maintain the assumption that the bilateral tariff between the US and the EU will be 10%. Despite the fluctuations of recent weeks, we still consider this a reasonable assumption, as it is a high enough tariff to exert pressure, but without provoking large-scale reprisals from the EU, thus avoiding much more adverse scenarios in both economies. On the other hand, we also maintain the assumption that the tariffs between the US and China will reach a level of 60% in 2025 (45 pps higher than in December 2024), but now this increase is expected to occur less gradually than previously thought and there is greater uncertainty surrounding the negotiation process. In this context, and also incorporating the fiscal boost in Germany and the EU’s defence plans, we anticipate that the euro will be trading around 8% higher against the dollar than the level anticipated a few months ago (1.14 euros/dollars at the end of this year, remaining around that level during 2026). As for oil and gas prices, given the greater risks of a slowdown in the global economy and high global supply, we expect they will be significantly lower (through to the end of 2026, the Brent barrel price will range between 62 and 65 dollars and that of gas between 30 and 35 euros per MWh). Overall, the risks to growth remain skewed to the downside, conditioned by the outcome of the US’ tariff negotiations and the response from its trading partners.

The European economy performed better than expected in Q1 of this year, and this has generated an upward knock-on effect of more than 0.2 pps for the euro area’s growth forecasts for 2025. This boost is expected to be reinforced by the fiscal stimulus plans announced in March, although our starting assumption, in the absence of a specific timetable, is that their implementation will be very gradual, with little impact until next year. We estimate that the boost to the growth of the euro area and Germany will be just over 0.1 pp in 2025, while in 2026 it could potentially exceed 0.2 pps in the euro area and around 0.5 pps in Germany. Finally, substantially lower energy prices than previously anticipated (along with the appreciation of the euro) will also sustain growth, especially in economies that use fossil fuels more intensively.

On the downside, much of the growth recorded in Q1 2025 appears to be explained by the boost to exports generated by the «anticipation effect» ahead of Trump’s tariff announcement, so we could foreseeably see a correction to the contrary in the coming quarters. The international context is now less favourable for the European economy, with the entry into force of the universal 10% tariff, risks of lower global growth and persistently high uncertainty, in addition to a more appreciated euro.

On balance, the euro area economy will show significant sluggishness and will not rebound until Q4 2025, skewing the growth forecast for 2026 to the downside. Thus, we have revised our growth forecast for 2025 upwards by 0.1 pp to 0.9%, but have cut the 2026 forecast by 0.3 pps to 1.1%, despite the positive effect of the fiscal boost. As for inflation, the lower than expected figures at the beginning of the year, coupled with a more favourable energy outlook and a stronger euro, lead us to revise our forecast for headline inflation in 2025 downwards by 0.4 pps, placing it at 2.0%, but without any significant changes to the 2026 estimate, which we keep at 1.9%. The predictions for core inflation have hardly changed and we are still anticipating a rate of 2.2% in 2025 and of 1.9% in 2026. In this context, we keep our forecast scenario for the ECB unchanged: we anticipate two further cuts in the depo rate this year, placing it at 1.75% in December.

The negative impact of the tariffs on US economic activity has been felt even earlier than we expected. Despite the resilience of domestic demand, GDP fell 0.1% in Q1 2025 due to a notable increase in imports in anticipation of the protectionist measures, generating a significant downward knock-on effect for growth in 2025 as a whole (almost –0.5 pps). While we expect some of this setback to be reversed in Q2 2025, the effect of the tariffs already in force and the persistence of uncertainty will weigh on economic activity, which will virtually stagnate in the second half of the year. Consequently, we have cut the expected growth rate for 2025 and 2026 by 0.8 and 0.3 pps, respectively, to 1.3% in both years.

On inflation, we anticipate a scenario with a more moderate increase in prices due to the lower-than-expected inflation rates recorded at the beginning of the year, foreseeably lower energy costs and the impact of a sharper economic slowdown. Thus, we have revised our inflation forecast for 2025 downwards by 0.2 pps, to 2.9%, and by 0.1 pp to 2.6% in 2026. In the core component, we keep our forecast for 2025 unchanged at 3.3% due to the pressure exerted by the tariffs on goods prices and the persistence of inflation in services, while we have lowered our 2026 forecast by 0.2 pps, to 3.0%, due to the more limited boost from private consumption.

In this context, we have slightly adjusted our rate expectations for the Fed. Specifically, we continue to expect one further rate cut in 2025, placing rates in the 4.00%-4.25% range, and we have incorporated three more cuts in 2026 (compared to just one previously), bringing them down to 3.25%-3.50% by December next year.

The tariff anticipation effect also had a significant impact on the performance of the Chinese economy in Q1 2025, with a growth rate of 1.2% driven by an increase in exports. We expect this effect will be transitory and, in fact, the outlook for the coming quarters has deteriorated substantially due to the impact of the protectionist escalation with the US. Although the 90-day truce reached in mid-May has, for now, quelled fears of the most adverse scenarios (an almost complete decoupling between the two economies), the tariff hikes have been faster than we had anticipated in our previous forecast scenario.

So far, China has managed to «pivot» its trade towards other destinations (mainly Asian countries) to compensate for the fall in exports to the US, and this pattern is likely to continue over the coming months. However, the weakness of its domestic demand makes it difficult for this component to take the reigns in a sustained way, in the absence of fiscal stimuli more oriented at boosting household spending and less focused on supply-side policies, as has been the case up until now. Nevertheless, we believe that the fiscal and monetary measures that have been implemented will limit the negative impact of the trade war, leading us to make only a slightly downward revision to our growth forecasts for China. Specifically, we have revised the growth forecast for 2025 down by 0.1 pp, to 4.1%, and down by 0.2 pps in 2026, to 3.7%.