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02 Jul 2025

Global Economic Overview – June 2025

Philip Shaw, Ryan Djajasaputra, Lottie Gosling, Ellie Henderson and Sandra Horsfield | London Economics team

The world continues to wait for news on where tariffs are to settle once the ‘Liberation Day’ truce ends on 9 July while hoping that the ceasefire in the Middle East holds. We have not made material changes to our GDP growth forecasts this month, which at the global level stay at 3.1% for both this year and next. The changed political reality though is stark. NATO’s newly agreed 5%/GDP annual defence spending target is a marked step up for European nations. It will add to GDP growth, especially in Germany. But fiscal pressures loom large as the ‘peace dividend’ is reversed, at an inopportune time.

Global Economic Overview - June 2025 PDF 1.82 MB

Summary

Global

As the world awaits news on where tariffs are to settle once the ‘Liberation Day’ truce ends on 9 July, the widening of the conflict in the Middle East to a direct confrontation between Israel and Iran, and the US getting involved, has added a new dimension of risk. The subsequent ceasefire has calmed nerves in oil and gas prices though. We assume this will hold and also – though without great conviction – that ultimately the current level of tariffs will apply after 9 July too. We have therefore not made material changes to our GDP growth forecasts this month, which at the global level stay at 3.1% for both this year and next. The changed political reality though is stark. NATO’s newly agreed 5%/GDP annual defence spending target is a marked step up for European nations. It will add to GDP growth, especially in Germany. But fiscal pressures loom large as the ‘peace dividend’ is reversed, at an inopportune time.

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United States

With little clarity over where tariffs will settle, the FOMC has maintained its wait-and-see approach towards policy changes, batting away calls from President Trump for sharply lower rates. Indeed, although the last few inflation reports have been favourable, this is unlikely to remain so, with companies warning of prices rises to come as higher tariffs make themselves felt. But trade levies are not the only policy dimension to consider when assessing the US economy: President Trump’s migration policies matter for the supply side, and we are watching the passage of the ‘One Big Beautiful Bill’ closely too, particularly as the lifting of the debt ceiling is tied up within this. For now, we keep our forecasts steady, predicting GDP growth of 1.6% this year and next, and just one interest rate cut from the Fed this year. Although our USD forecasts also remain unchanged, we see the risks as tilted to further dollar weakness.

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Eurozone

Distortions related to the frontloading of US orders helped boost Q1 GDP growth to its strongest quarterly pace since Q2 ’22, at 0.6%. However, that is likely to prove temporary with April figures already pointing to some payback. As a baseline we see the Euro area achieving modest GDP growth this year and next; our forecasts are unchanged at 1.0% and 1.5%, respectively. That said downside risks are evident, the key being the outcome in EU-US tariff negotiations. In the event that the EU avoids punitive US tariffs we now anticipate ECB policy to stay in a holding pattern with the Deposit rate remaining at 2.00%. Meanwhile we continue to see arguments for a stronger euro in the medium term. Our current end-year ’25 and ’26 €:$ forecasts of $1.17 and $1.20, respectively, are subject to upside risks from a weaker US dollar.

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United Kingdom

It has become clearer that the 0.7% quarterly rise in GDP in Q1 was an aberration due to factors such as forestalling of US tariffs and perhaps questionable seasonal adjustment. The growth profile looking ahead for 2025 looks more modest and our GDP forecasts are +1.2% for this year and +1.6% next, little changed from last month. Despite volatile energy prices, we stand by our view of trend disinflation, which is supported by moderating pay growth. We still see two further cuts in the Bank rate to 3.75% by end-year. With rising term premiums in the gilt market, the MPC has a tough decision to make regarding its QT programme over the next year. A related point is that the DMO is tilting gilt issuance away from the long end. Sterling hit $1.3750 recently, but despite the risk of further USD falls we have kept our $1.35 end-year target and note from options markets the rising costs of insuring against a USD rally.

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Global

Until recently, it looked as though the approaching deadline of 9 July for US tariff negotiations to conclude in order to stave off ‘reciprocal’ tariffs would be the dominant topic in financial markets this month. This certainly remains a crucial issue. At the time of writing, no additional deals besides the UK’s have been announced. The threat of tariffs on pharmaceutical goods imported into the US, hitherto exempt from Trump’s extra tariffs but under investigation, has been ramped up too, with Trump indicating these were planned ‘very soon’. The EU20 (and within that, Ireland) could be affected the most (Chart 1). We calculate that a US pharma tariff of, say, 25%, would add an extra 1.6%pts to the US average tariff rate.

Chart 1: The Eurozone, and most so Ireland, are very exposed to any US pharma tariffs

Source: US Census Bureau, IMF, Investec Economics, Macrobond

That said, it is far from clear where tariffs will settle – on pharma or indeed on all other items. For the purposes of our forecasts this month, we have assumed that trade talks will be extended past 9 July (and for China, past 12 August) and that all tariffs stay where they currently are, triggering no retaliation. This would come at a cost to global trade and GDP growth, but not to a greater extent than we had predicted last month. Indeed, our global GDP growth forecasts for 2025 and 2026 are unchanged, at 3.1% for both years (Chart 2). That tariffs remain unchanged is an assumption, not a forecast that we can have much conviction in; the risk of the US re-escalating tariff rises clearly looms large.

Chart 2: Our GDP forecasts, little changed this month, assume tariffs stay as they are

Source: IMF, Investec Economics, Macrobond

This is widely recognised. Yet despite this uncertainty, markets have recovered their poise relative to the weeks immediately after ‘Liberation Day’ in early April: stocks are up, and USD has reverted to moving in the same direction as yield spreads (Chart 3). One key reason why appears to be what FT journalist Robert Armstrong labelled the ‘Taco’ trade – Trump Always Chickens Out. He attributed Trump’s (temporary) back-tracking on 9 April from the ‘Liberation Day’ announcements to the unfavourable market reaction having pushed the President past his pain threshold. Market pricing now is consistent with a bet on Trump ultimately shying away from extreme tariff measures in future too, for fear of causing material harm to his supporters’ and financial backers’ livelihoods and savings.

Chart 3: The US dollar is now back to moving in the same direction as yield differentials

Source: U.S. Treasury, Investec Economics, Macrobond

That is not certain though. There has been some retaliation already to Trump’s tariffs: Canada has put some retaliatory tariffs on US cars and steel & aluminium. More are lined up: unless rescinded by 14 July, the EU will add counter-tariffs on €21bn of US goods in response to the 25% steel & aluminium tariff rise. Higher tariffs are considered on an extra €95bn of US goods, as are measures to cap imports of US services. Canada too is threatening to lift steel & aluminium tariffs on the US further on 21 July if no deal is struck. Should ‘Taco’ not play out, given high equity valuations, most so in the US (Chart 4), stock markets look vulnerable to a fall. If so, with hindsight, equities may be accused of having been complacent in the runup to 9 July.

Chart 4: US equity valuations are still high by historical standards and relative to others

Note: Uses 12m forward consensus earnings per share
Source: Bloomberg, Investec Economics, Macrobond

On top of all this, a new dimension of risk has opened up. Israel’s military action against Iran, and the US’s bombing of Iranian nuclear sites, marked a widening of the conflict in the Middle East. This pushed up oil and natural gas prices, but these fell back as a ceasefire was declared (Chart 5). If the ceasefire holds – as we assume – the impact on the world economy from the conflict should stay limited. But there is a risk of re-escalation. In that case, oil and gas prices could surge, which would add to inflation. Indicatively, various models suggest a 10% oil price rise may cut world GDP growth by c.0.2%pts. The hit would be largest for energy importers such as the EU20 and the UK, who could see their currencies weaken – also vis-à-vis USD, resuming what was seen earlier in June.

Chart 5: Energy prices rose as Israel and the US took military action against Iran, then fell

Note: Chart shows front contracts.
Source: ICE, Investec Economics, Macrobond

Unsurprisingly in this global context, and with the war in Ukraine ongoing, pressure to raise defence spending is high. At the NATO summit, a rise in the target from 2% now to 5%/GDP p.a. by 2035 was agreed. How to fund this, or what part of government spending to cut to offset the added cost, will cause headaches to NATO’s governments. What might be termed the opposite of the previous ‘peace dividend’, which had freed up fiscal resources during a more settled period of history, comes at a difficult time, colliding with high debt and now rising debt service costs, unfavourable demographics and the burden of dealing with climate change. We expect this to keep bond yields higher.

Chart 6: Government debt servicing costs are rising, squeezing room for fiscal spending

Source: IMF, OECD, Eurostat, BEA, Investec Economics, Macrobond
United States

The US economy has consistently defied expectations of a slowdown over the past few years. The next big test however is whether the economy will remain resilient in the face of tariffs. The impact on the economy will of course depend on where tariff rates eventually settle, but on the basis that the effective tariff rate stays around its current estimated level of 15.8%, we expect the economy to slow but not buckle under Mr Trump’s more punitive trade policy. Current economic data is being distorted by a change in consumer behaviour around ‘Liberation Day’ (Chart 7), but broadly it appears as if economic momentum is holding up. A further factor to consider is how supply plays into this, with Trump’s migration plans altering population trends.

Chart 7: Retail sales data point to tariff frontrunning impacting Q1/Q2 economic data

Source: Investec Economics, Census Bureau, Macrobond

Inflation data in the US have been benign recently, with the anticipated tariff induced spike not yet emerging in the official figures. But anecdotal evidence suggests that this trend is unlikely to last. Indeed, companies are likely still running down existing inventory, but this of course is finite and Walmart, Mattel, and Best Buy, have warned of price increases due to tariffs. This mirrors evidence in the Federal Reserve's latest Beige Book which reported expectations for 'costs and prices to rise at a faster rate going forward', whilst the June flash PMI report noted price pressures rising ‘sharply’ across both manufacturing and service sectors; all of which point to upside risks to inflation in coming months.

Chart 8: Encouraging inflation reports unlikely to stay with firms warning of price rises

Source: Investec Economics, BEA, BLS, Macrobond

Fed Chair Powell shares the view that inflation will likely rise due to higher tariffs. With the economy holding up despite restrictive policy, the majority on the FOMC seems comfortable to continue with the wait-and-see approach until the landing point for tariffs (and thus the degree of potential extra price pressure) is clearer. A division appears to be forming on the FOMC though, with Govs. Waller and Bowman (both Trump appointees) hinting at support for a cut as early as next month. However the direction of travel is in the other direction – June’s ‘dot plot’ shows that the average committee member has become more hawkish on rates this year (Chart 9). Our base case remains that the FOMC will not ease again until December.

Chart 9: Median view unchanged but more FOMC members expect no rate cuts at all this year

Source: Investec Economics, Federal Reserve

With tariff, and then Iran, news dominating the media, it is easy to lose sight of the domestic agenda. Here President Trump is trying to get his One Big Beautiful Bill Act (OBBBA) through Congress and to his desk by 4 July. However, the bill is facing heavy opposition from all sides, making passage difficult. At the time of writing the bill is being debated in the Senate, having already narrowly passed the House. But to push the bill through the Senate, changes are being made, which will run counter to House demands. Issues centre over the ending of green energy credits, the SALT cap, cuts to Medicaid and the overall cost of the bill: the CBO estimates the House-passed bill will add $3trn (inc. interest) to US debt by 2034.

Chart 10: How do the big disagreements between the House and the Senate get settled?

Source: Investec Economics, Congressional Research Service

Although 4 July is a self-imposed deadline by Mr Trump, mid-August is not. This is the earliest CBO estimate of the ‘X-date’ when ‘extraordinary measures’ to prevent a breach of the debt ceiling are no longer possible. In a political manoeuvre, the lifting of the debt ceiling has been tied with the OBBBA – hence the high stakes to get the bill passed. Given the risk of a default, it is unlikely that the debt ceiling will not be raised/suspended. But Congress could (and has previously!) let it run to the wire, exacerbating already existing fiscal fears linked to looming debt burdens. We think that fiscal concerns will prevent a marked fall in UST yields in 2026, despite our forecast for 75bps of Fed cuts next year.

Chart 11: Fiscal concerns likely to prevent sustained falls in Treasury yields

Source: Investec Economics, Federal Reserve, Macrobond

A further reason behind our profile of just a slow downward trend in yields (we forecast end-26 10y UST yields at 4.25%) is general caution towards US assets. Although the US’s safe haven status has not been lost, as was demonstrated by the rise in USD amidst Middle East tensions, investors do seem to be seeking a more diversified portfolio of safe assets, to the benefit of assets such as the EUR and gold. Mr Trump’s constant criticism and threats to Fed Chair Powell probably does not help boost investor confidence in the US either. An exception to this is US equity markets, which have rallied in recent weeks. We wonder if equity markets are too complacent though, particularly in the face of the looming 9 July deadline in which reciprocal tariffs could be reimposed.

Chart 12: Has the TACO trade gone too far? Are US equity markets too complacent?

Source: Investec Economics, Macrobond
Eurozone

Significant revisions to Q1 GDP saw the pace of growth doubled to 0.6% q/q, its strongest reading since Q3 ’22. However, this pace of growth is likely to prove temporary given that it was boosted by a frontloading of orders to the US ahead of tariff rises. This was most evident in Ireland where growth was revised up to 9.7% q/q, thus contributing 0.4%pts to EU20 growth. We suspect that Q2 will see some payback, with April figures already providing some evidence of this: exports to the US were down 35% m/m, whilst industrial output fell 2.4%, with the latter driven by a 15% plunge in Ireland. In terms of Q2 we see a 0.3% fall in GDP as the frontloading effect reverses, particularly in Ireland.

Chart 13: April data points to some payback from frontloading ahead of US tariffs

Source: Investec Economics, Macrobond

What matters for the outlook is where tariffs finally land, with President Trump’s threat of a 50% reciprocal tariff hanging over the EU. Reports have suggested that the EU may be willing to accept a 10% baseline rate, but there is little indication as to whether this is acceptable to the US. Our assumption is that talks will be pushed out beyond the current 9-Jul deadline. As such we maintain our growth forecast at 1.0% and 1.5% for ’25 and ’26 respectively. However, downside risks are clear. Firstly, we could be wrong on tariffs and Trump may impose punitive duties next month. Secondly, should the ceasefire between Israel and Iran break down, a spike in energy prices might yet ensue, with Germany’s energy intensive industries at particular risk.

Chart 14: Tariff factors to distort H1’25, growth expected beyond, but downside risk remain

Source: Investec Economics, Macrobond

Amidst this uncertainty ECB messaging seems to have borrowed a phrase from the Fed, in that policy is judged to be in ‘a good position’ to navigate the uncertain outlook, effectively suggesting that a pause is ahead. Indeed, with rates now around neutral and inflation back to target, we too see the Deposit rate remaining at the current 2.00% level. But tariff changes may yet thwart that. Should the US implement tariff rates toward the higher end of Trump’s threats, then further cuts would become likely. The ECB’s June set of projections did include a severe tariff scenario which saw 2025 GDP growth cut to 0.5%, a figure which would implicitly imply a recession. In that case we judge the ECB would feel compelled to cut, despite the inflationary impulse from likely EU tariff retaliation.

Chart 15: ECB pause ahead with policy deemed to be in ‘a good position’

Source: Investec Economics, Macrobond

Inflation outturns, including May’s 2.3% core HICP reading, have been one factor in the ECB’s growing comfort with current policy positioning. News on services inflation has been more encouraging still. April’s spike proved to be temporary, distorted by the timing of Easter, with May’s reading fully unwinding the rise and falling to its lowest since Mar-22. At 3.2% it signals genuine disinflation after having been stuck at 4% throughout 2024. Another is the ECB’s growing confidence that the return of inflation to the 2% target will prove durable. This is underpinned by its view that wage growth will return to levels consistent with target. Supporting this prediction is its latest wage tracker, which indicated wage growth easing to 1.6% in Q4’25.

Chart 16: Inflation pressures have been easing

Source: Investec Economics, Macrobond

Germany’s new coalition government continues to push ahead with its ambition to increase defence spending, committing to the new NATO 5%/GDP target. The 2025 draft budget, backed by Chancellor Merz’s cabinet, sees the defence budget more than double by 2029, rising to €152.8bn. That will be financed by more borrowing. Thanks to the debt brake reform, Germany can now borrow more to fund defence, with net new borrowing to total almost €500bn over the five years to 2029. Although the draft budget still needs to be approved in both the Bundestag and Bundesrat, which is not expected until the end of September, the proposed increase in borrowing will likely put upward pressure on Bund yields.

Chart 17: Germany to increase defence spending more rapidly than France or the UK

Source: NATO, Government pledges, Investec Economics, Macrobond

June has been a strong month for EUR, which has gained 4% against the USD since our last Global (23-May). At $1.1735 it is now trading at levels last seen in Sep-21. Interest rate differentials have typically been an influence over €:$ (see Chart 3). But FX movements this year suggest other factors are at play too. An open question is whether international markets are starting to view EUR as an alternative safe asset to USD. On this it is hard to find definitive evidence, but bond flows would point to i) EU20 investors returning to domestic markets, and ii) greater foreign flows into euro markets. We suspect a continuation of this trend will support the Euro and as such maintain our end ’25 and ’26 €:$ forecast at $1.17 and $1.20 respectively.

Chart 18: Cross-border bond investment flows^#

# Investment flows into bonds via investment funds, current represent flows for Mar, Apr and May
Source: Investec Economics, Macrobond, ECB
United Kingdom

GDP fell by 0.2% m/m in April after a buoyant start to the year had resulted in growth of 0.7% q/q in Q1 as a whole. A key phrase here is 'payback', in that industry ramped up output in Q1 to forestall US tariff hikes. Surging housing transactions ahead of a reversion to a less generous stamp duty regime supported activity too. We also suspect that seasonal adjustment could be faulty as GDP outturns tend to be firmer than average at the start of the year. May’s GDP could have been weak as well, given that retail sales fell back by 2.7% on the month, reversing a robust showing hitherto in 2025. Overall our 2025 GDP forecast has been tweaked down to +1.2% from +1.3%, while that for 2026 remains at +1.6%.

Chart 19: A strong start to 2025 GDP, but payback likely in Q2

Source: ONS, Investec Economics, Macrobond

The ONS erred in calculating vehicle excise duty changes in April, leading to CPI inflation being overstated by 0.1%pt at 3.5%. This will not be revised. Inflation fell to 3.4% in May, partly thanks to a swing in airfares, which had been inflated more this April than in ‘24 due to the timing of Easter. For now, we judge that volatile global energy prices will not disrupt the disinflation narrative. Indeed labour market conditions continue to loosen - notably private sector regular pay growth fell to 5.1% in April; lower rates were last seen in ‘22. The MPC kept the Bank rate at 4.25% this month, as expected. But three members backed a 25bp reduction, reinforcing our view of two further rate cuts to 3.75% by year-end.

Chart 20: Official data show a clear moderation in pay growth

Source: ONS, Investec Economics, Macrobond

Rising term premiums in the gilt market are set to influence the BoE’s next moves on QT. Over the past two years, the MPC has opted to reduce the stock of gilts in its Asset Purchase Facility portfolio (built up by QE) by £100bn pa between Oct and the following Sep. This was more than the value of gilts that redeemed, with the desired rundown achieved by active sales. In the current QT period, £87bn of APF gilts were due to expire, resulting in a relatively modest £13bn of active sales. The committee is set to decide upon next year's QT programme in Sep. Over the following year, redemptions will total just £49bn, so to achieve the same rundown as the past two years, sales would need to be a far greater £51bn, risking further upward pressure on long yields.

Chart 21: Keeping the QT target at £100bn next year would imply a big step up in active sales

Source: Investec Economics, Macrobond

To prevent excess volatility, the BoE could scale back the pace of QT or skew sales more towards the short end of the curve. In this respect note that the BoE suspended a long gilt sale in April due to fragile market conditions. Similarly the Debt Management Office has begun to reduce the average maturity of its gilt issuance (Chart 22). The reason here is that demand for long-dated paper from pension funds has waned, as there are relatively few Defined Benefit schemes which need to match their (long-term) liabilities, with many having eliminated their deficits. In 2025/26, the DMO plans £299bn of gross gilt issuance, and although structural factors underpin the greater skew towards short gilts, market conditions will also be a relevant factor.

Chart 22: The DMO is tilting the maturity of its gilt issuance away from longer-dated debt

Source: DMO, Investec Economics

With two months of data for the new fiscal year available, public sector borrowing has been running at some £1.5bn per month below the OBR's projections, implying that the government's fiscal rules are, for now, still on track to be met. Even so, it is early days and many risks remain. For example, the fiscal arithmetic could be blown off course by stalling growth, a rise in inflation or higher long-term (and even short-term) interest rates. Although our own forecasts do not explicitly incorporate tax hikes to meet the fiscal rules, it is virtually inevitable that such speculation mounts ahead of the Budget in the autumn. A consequent risk is that GBP and gilts may show signs of nerves, on fears that the rules may be watered down or even abandoned.

Chart 23: Fiscal rules and forecast margins at the Spring Statement

Source: OBR, Investec Economics

Sterling:dollar has recently traded at a 50-month high above $1.3750. We have held our end-year forecast of $1.35, despite considering an upgrade. Options markets though suggest sentiment is cautious over this. Implied volatility has fallen for calls over the current spot price but is actually higher for sterling puts (Chart 24). In plainer English, this means that the cost of insuring against a large fall in the pound versus the US dollar has become more expensive. This shift is not based on domestic factors (similar trends are visible in other markets such as euro:dollar) but reflects uncertainty over developments in the Middle East and the chances of a large rebound in the US unit in the event of a reignition of tensions.

Chart 24: Options pricing shows it has become more expensive to insure against a fall in GBP

*Note that the x-axis denotes ‘deltas’ in terms of puts and calls. Source: Bloomberg, Investec Economics, Macrobond