Global Economic Outlook

Arend KAPTEYN, Global Head of Economics and Strategy Research, UBS

Executive Summary

The fundamentals of the global economy are improving: the inflation and interest rate shocks of the last few years are subsiding, real income growth is running at 20-year highs globally, housing prices are starting to inflect higher as interest rates come down, and credit growth is no longer falling. There are also signs that global trade is starting to recover, possibly because the shift back from goods to services consumption, post Covid, is now largely complete. Labour markets remain tight despite some increase in global unemployment, and vacancy to unemployment ratios are generally back at roughly 2019 levels.

Yet despite this list of improvements we forecast global growth to slow, from roughly 3.3% in 2024, to 3% in 2025 and then 2.7% in 2026. That is mainly because of the trend slowdown that is underway in the US, and China. In the US we are seeing the fading effects of fiscal stimulus. The US is ultimately a 2% rather than a 3% economy, but fiscal policy added a full 1 percentage point of excess growth in recent years. At the same time, there are signs that consumer spending could be increasingly constrained. The bottom 80% of the US income distribution has seen a 2-3 standard deviation drawdown in their liquidity position; the question is now how long the top 20% can continue to offset this.

In China, the weakness remains mostly concentrated in the property sector. We expect full stabilization by the middle of next year and that property activity may subtract between 1.5 and 2 percentage points from growth this year. Substantial stimulus has been rolled out. To remove the excess housing inventory in lower cities, we hope to see more stimulus and the funding rate for local governments to fall below the rental rate.

The other big factor in the outlook is US tariffs. Our China forecasts already include tariffs, but our rest of the world forecasts do not. We are waiting for the America First Trade Policy Review to compete (by April 1) after which perhaps we get more tariff clarity. The tariffs that have so far been announced or threatened (close to $800bn) are 7-8x larger than what was implemented in 2018-2019. There is duplication in the announcements, however, (e.g. do sectoral tariffs need to be added to country tariffs or are they part of the aggregate country total) and some of the proposals which are said to be important don’t seem consistent with the US administration’s goals. For instance, reciprocal tariffs, by our estimate, would imply less than a 2pp increase in the weighted average import tariff for the US and raise very little revenue. We doubt that is what the White House had in mind.

Tariffs are by far the biggest risk to the outlook and if even half of the announcements materialize we may need to lower our global growth forecast.

By contrast, one of the biggest upside risks is Europe. The US’ reduced commitment to the war in Ukraine has spurred the EU into action. Defence expenditure is likely to be excluded from European fiscal rules, allowing for a significant ramp-up, likely only 0.3pp or so in the short run but ultimately Europe could increase its spending levels by as much as 1pp. In addition, Germany is changing the constitution to establish an investment fund of 11.5% of GDP, over 10 years. That has the potential to substantially lift Germany’s growth in the short term, with positive spillover to the rest of Europe. This is, however, mostly a 2026 and beyond story; this year’s outlook is much more dependent on tariffs.

Moreover, if there is a peace deal for Ukraine, the estimate reconstruction needs are over EUR500bn. How that will be funded is still unclear (possibly common issuance) but depending on how quickly it can get pushed out the door that provides meaningful additional stimulus. Beyond that, lower energy prices (if the peace deal is perceived to be lasting and enforceable) and improved confidence, are other potentially positive factors, that account for about half of the growth boost we think would come from a peace deal.

Central bank policy outside the US is likely to remain supportive, and we expect easing to continue. Global wage growth is still slowing, energy and goods price inflation have normalized, and core inflation is only about 60 basis point away from its pre-pandemic ‘run-rate’ (that would need to be sustained to fully see it in the annual numbers). In other words, the global economy is generally still disinflating, and growth remains somewhat sub-trend, thus allowing for continued easing. Tariffs complicate that outlook but for most countries they do much more damage to growth than they lift inflation, particularly if retaliation remains restrained. For the Fed the situation is more complicated, as they will need to incorporate a multitude of tariffs into their forecast. Our baseline is that they cut twice more in the 2nd half of this year, but would have to backload the residual easing until the tariff effects have passed in 2026/2027.

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