Jumana Saleheen, Chief Economist, Vanguard, Europe comments:
“Something had to be the catalyst. After a steady, upward march of U.S. equities valuations, especially those of large growth companies, something had to precipitate a reversal. Looking forward, in the U.S we anticipate lower growth, and higher inflation. Outside the US we anticipate weakening economic growth, although softening demand will likely temper any inflationary impulses. For investors, discipline is key. Sharp market downturns are a surprise only in their timing, not in their occurrence. Don’t chase the markets and, as Jack Bogle was fond of saying, stay the course. Eventually, and not necessarily in this order, volatility subsides, markets bottom, and the dance ends.”
The rapidly evolving developments related to trade tariffs continue to dominate financial markets and alter potential economic scenarios.
Our revised economic forecasts broadly reflect our view that US tariffs are likely to cause GDP growth to slow both in the US and in major economies outside the US. However, outside the US, we don’t expect to see an increase in the pace of inflation to the degree that we do in the US given the likely effect of weakening demand on prices.
Under our revised baseline scenario, 2025 US GDP growth would fall below 1%. That would put the economy at a potential “stall speed” that raises the spectre of recession.
We also foresee US core inflation ending 2025 at nearly 4% year over year, while we expect the unemployment rate to rise just above 5% by year-end, which would be the highest in a decade outside the Covid-19 era.
Below, we focus on the changes we’ve made to our economic forecasts for four major economies outside the US: the euro area, the UK, Japan and China.
Though the situation is fluid, these forecast revisions can help provide an anchor for expectations in what is a highly uncertain macroeconomic environment.
Euro area
We had estimated the tariff announcements on 2 April would have increased the effective tariff rate on the EU to 15%. This, together with expected additional tariffs on sectors currently exempt (including pharmaceuticals and semiconductors), would have pushed the effective tariff rate above 20%.
However, the 90-day pause announced on 9 April has dampened this impact somewhat. If it sticks, and the sector-specific tariffs are implemented as we expect, the effective tariff rate on the EU would be closer to 15%.
Higher tariffs will weigh on growth. We have downgraded our forecast for 2025 euro area GDP growth to less than 1% and our 2026 forecast to around 1.0%. This counteracts the gains expected from Germany’s large-scale fiscal programme announced in March, greater euro area-wide defence spending and the prospect of a ceasefire in Ukraine.
We have also upgraded our year-end 2025 euro area CPI forecast to just under 2% but have downgraded our year-end 2026 forecast amid weakening demand.
A softer growth and medium-term inflation outlook implies a more dovish European Central Bank (ECB). We have added two cuts to our previous forecast and now expect the ECB policy rate to fall to 1.75% (previously 2.25%), with a 0.25 point cut at the central bank’s April meeting likely.
UK
The UK economy is likely to be only modestly affected by higher tariffs from the US. We estimate the effective tariff rate on the UK has increased by around six percentage points, though this is likely to increase with future tariff announcements on sectors such as pharmaceuticals.
Given that tariffs could eventually be diluted after negotiation, this has led us to increase our base case effective tariff rate on the UK from 2% to 7%.
We have consequently downgraded our GDP growth forecasts to around 0.5% in 2025 and just below 1% in 2026. We now expect headline inflation to end the year around 2.5%, slightly above our previous forecast, but we have downgraded our 2026 forecast to around 2.0%.
We continue to expect the Bank of England to maintain a quarterly cadence of easing, including a 0.25 point interest rate cut in May. If this view plays out, the Bank Rate would end the year at 3.75%.
Japan
We have downgraded our Japan 2025 growth forecast to below 1%. We expect tariffs to exert downward pressure on the Japanese economy via an economic downturn in the US and surrounding regions and a decline in the price competitiveness of Japanese exports within the US.
We continue to expect the Bank of Japan to gradually tighten monetary policy, potentially seeing interest rates near 1% by the end of this year.
China
We have revised our 2025 GDP growth forecast for China from 4.5% to closer to 4%. This downgrade is driven by the direct hit to exports from higher tariffs, reduced household and business sentiment and weaker global growth.
However, the extent of the slowdown is expected to be cushioned by more aggressive policy easing. Boosting consumption demand will be a top priority for China’s policymakers in the face of tariffs and we see scope for considerable fiscal stimulus to bolster household balance sheets. We also expect the People’s Bank of China to enact monetary policy easing, with the central bank likely to cut interest rates soon.
On the inflation front, we now think the annual rate for core CPI inflation will end the year around 0.5% and headline CPI below that.
