To read the full article, see the Investment Strategy Quarterly publication linked below.
The global economy will grow in 2025 – a high degree of conviction in a world mired in uncertainty following President Donald Trump’s victory, but outcomes will vary and become more dispersed. Outside the US the biggest improvement to global real GDP prospects will be in Japan and to a lesser extent the UK. In contrast, persistent structural headwinds will hamper the euro zone and growth will be lackluster at best. Of the emerging markets, the Chinese economy will grow again but the pace will slacken as Beijing adjusts its focus away from the export sector and towards stimulating domestic demand. India has enjoyed a strong start to the decade and will remain the fastest growing major economy next year. Inflationary pressure, the focus of central bank policy measures over the past few years, will slowly normalize but with variance across differing geographical locations. This variance will manifest in a divergent approach to monetary policy between systemic central banks, with the Bank of Japan cautiously raising interest rates while restrictive policy is loosened gradually elsewhere.
For markets, the combination of moderate but still positive growth, subdued inflationary pressures, and supportive monetary policy is constructive for positive returns over the year ahead. Investors will, however, be mindful of the risks associated with a wide range of potential policy initiatives, market sensitivity driven by the substance, weight, and timing of measures which could deliver notably divergent investing outcomes.
For China, the domestic challenges trump the tariff impact
The imposition of large tariffs on Chinese exports would damage the country’s export sector – but goods exports to the US amount to less than 3% of China’s GDP. Taking account of possible exchange rate weakness, some possible attempts at evasion (perhaps through re-routing exports via a third country subject to a lower tariff, such as Vietnam) and the redirection of manufacturing output to other destinations, the overall impact of even a 60% tariff could drop to less than 1% of GDP. The impact may likely be offset by lower interest rates and particularly fiscal policy expansion in part aimed at heading off the threat of insolvency in the real estate and financial sectors.
Eurozone faces persistent structural headwinds
The direct impact of the threatened 10% tariff on all US imports, although an additional cost for exporters, would only amount to a fraction of a percent of eurozone GDP. However, the impact would be greater on Germany as the US is one of its key export markets. The extent to which the region is impacted will depend on the extent to which tariff imposition might be diluted through negotiated concessions from the European Union as was the case in the automotive sector in 2018. Furthermore, exports to the United States account for only a small proportion of regional economic activity and the overall impact might be further diminished were the threatened 10% universal tariff applied to all countries, thus not placing the eurozone at a competitive disadvantage elsewhere. That being said, indirect knock-on developments could impose a greater cost to the eurozone, notably a broader shift towards protectionism.
Tariff impacts on Japan and the UK?
If China is no longer to be the United States’ ‘Most Favored Nation,’ might that mantle shift to Japan? Whilst standing ready for tariff imposition, Japan’s free trade agreement with the US may mean its economy gets off lightly. Note that Japan sees itself as a good partner to the US, with total investment hitting $783 billion (15% of total cumulative foreign direct investment into the US in 2023). This may not be good enough for the Trump administration given Japan’s economic relationship with China. Facing long-term structural headwinds of its own, a contrite (and unstable) minority ruling coalition has agreed to a JPY 13.9 trillion ($92.4bn) supplementary budget containing stimulus measures aimed at reflating the economy through increased consumption. This would add 0.6% to real GDP growth in 2025 alone, through increased consumption and public works spending and further expansionary fiscal policy measures cannot be ruled out.
