Global Economic Outlook: Under pressure

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Source: Aberdeen, Haver, September 2025

US growth slows…

US economic growth slowed throughout the first half of this year, as tariff uncertainty weighed on sentiment – deterring firms from making investment decisions and households from spending. The labour market is weakening, with payrolls growth much lower, and further downward revisions to the jobs data are possible.

However, peak trade uncertainty has probably passed. Admittedly, the legal battle around the president’s use of the International Emergency Economic Powers Act (IEEPA) to impose tariffs creates some residual uncertainty. But the likely landing zone for the new trade regime is seemingly clear. Reduced uncertainty may lead to a mini growth pickup, as pent-up demand is unleashed.

…even as inflation looms

The transfer of increased costs associated with tariffs into inflation has been slower than we’d expected due to inventory run-down, transhipments and administrative issues. But as these factors fade, we expect core inflation to rise to 3.6% in the coming months.

Real income growth will be squeezed by this higher inflation, weighing on consumption. But ultimately the inflation shock is likely to prove a one-off hit to prices, especially as a weaker labour market makes it harder for households to negotiate pay increases. All told, we are forecasting US economic growth of just 1.6% next year and 1.8% in 2027, with inflation averaging 2.9% in 2026 and 2.1% in 2027.

But the weakening in the labour market has created a new downside scenario, in which self-reinforcing dynamics may lead to economic stalling and the US enters a recession.

Fed feels the squeeze

At the best of times, the combination of weaker growth and higher inflation would present a policy dilemma for the Federal Reserve (Fed). But with the US central bank facing significant political pressure, the policy environment is even more challenging.

We expect the Fed to cut interest rates by 25 basis points (0.25%) in September and again in December, with a further 75bps of reductions next year. That said, it is possible there are Fed governors in favour of a 50bps cut at the September meeting as President Donald Trump’s influence starts to be felt, or three 25bps cuts over the reminder of this year given the slowdown in the labour market.

A big picture risk is the extent to which the administration is attempting to influence interest rates, which could lead to a profound restructuring of the conduct of monetary policy. The president has couched his argument for lower rates in terms of reducing government funding costs. This increases our concerns about fiscal dominance.

So even as rates come down for bonds with shorter tenors, this could trigger a bond market rout in which longer-maturity bonds sell off. In an extreme scenario, a politicised Fed may use its balance sheet to hold down US bond yields through so-called ‘yield-curve control’.

China’s problems persist

In China, the tariff shock has been somewhat mitigated by export strength to markets other than the US. But, with transhipment tariffs now in place to deal with Chinese goods produced or assembled outside China, the hit to activity is likely to increase. Meanwhile, falling house prices and weak sentiment continue to weigh on consumption and investment.

The ‘anti-involution’ campaign may help reduce excess capacity in sectors like electric vehicles (EVs) and solar power. Involution refers to excessive and self-defeating competition – a process which rapidly created world-class industries but also led to aggressive price wars and declining profitability.

However, we think the campaign will fall short of what’s needed to bring weak inflation up to target. More generally, the degree of policy easing looks insufficient to materially boost nominal growth.

Better news for (most of) Europe

By contrast, the easing in European fiscal policy is set to boost growth from the tail end of 2026 and into 2027, even if leakages from defence spending are likely to be high.

While inflation is likely to fall back below the European Central Bank’s (ECB) target in the coming months, the eventual impact of fiscal easing should keep policymakers satisfied with regards to the medium-term path of inflation across the Eurozone.

So, we think the ECB has reached the end of its cutting cycle, and the next move may be a rate hike at the furthest end of our forecast horizon.

If Europe can combine fiscal easing with some of the supply-side reforms envisioned in the Draghi report – a strategy to boost Europe’s long-term competitiveness – this could unlock a regional spending surge.

We don’t expect an imminent ceasefire in Ukraine because of irreconcilable differences. But in one upside scenario, a peace deal could support European growth via lower energy prices, a boost in sentiment, reconstruction spending and even greater defence spending (depending on the terms of the deal).

UK inflation is set to increase further in coming months, peaking around 4%, so the risk the Bank of England keeps rates on hold for an extended period has increased. On balance, we still expect another cut in November and quarterly cuts next year, given the ongoing deterioration in the labour market. Fiscal policy will tighten again in this year’s budget, with a variety of tax tweaks likely.

A mixed bag elsewhere

We expect the Bank of Japan to next hike rates in January 2026. An earlier increase is possible, but we think ongoing trade and political uncertainties will see the central bank wait a little longer to better assess domestic inflation trends.

India faces a 50% tariff rate on exports to the US following the additional 25% imposed as punishment for its Russian-energy imports. That said, we expect a face-saving compromise before year-end. In this environment, the Reserve Bank of India would probably keep rates on hold this year. But if a deal proves elusive, this would undermine India’s appeal as a supply-chain relocation destination.

The broader emerging markets (EM) outlook has improved as tariff uncertainty has peaked. The EM rate-cutting cycle continues, and we expect more central banks to deliver cuts as the focus shifts from containing inflation to supporting growth, and the Fed resumes easing.