Global growth to remain subdued

As we head into summer, several major international organisations have revised expectations downwards in their updated global growth forecasts.

The OECD is the latest to publish its revised Global Economic Outlook, following the World Bank and, a few weeks earlier, the International Monetary Fund. The organisation expects global growth to slip below 3% in both 2025 and in 2026, blaming the combined effect of trade barriers and weaker business and consumer confidence. According to the OECD’s projections, growth in the United States is expected to slow sharply, from a pace of 2.8% in 2024 to only 1.6% in 2025 and lower still to 1.5% in 2026.

Although the US economy contracted in the first quarter, largely due to surging imports of goods as companies rushed to get ahead of new trade tariffs, the latest data for the second quarter show greater momentum, particularly in private consumption.

Are these international bodies overly pessimistic?

We think not. The risk of a slowdown in domestic demand remains a concern. The blow from the increase in US tariffs – from 2.5% at the end of 2024 to around 15% currently – will hit the economy harder in the second half, with both inflation and unemployment expected to rise.

Modest slowdown in the jobs market

The OECD confirms the steady slowdown in the labour market. The US created 139,000 jobs in May, slightly higher than market expectations, but below the average of 177,000 new jobs recorded over the previous six months. In the private sector, only nine industries added jobs last month, down from 12 in April and 13 in March. The employment rate also fell to 59.7, its lowest level since December 2021.

Source: BLS, Banque de Luxembourg

US inflation remains muted.

US monthly inflation edged up +0.1% in May, bringing the annual inflation rate to a moderate 2.4%. However, fears of a tariff-driven surge in prices stoked by the Trump administration’s protectionist measures cannot be dismissed. Price increases could feed through in the next few months and deliver a more sustained impact on inflation. In all probability, companies have been drawing on the inventories built up over the first quarter to temporarily avoid price hikes. There is also a time lag to consider as the goods hit by higher tariffs – from China notably – take between one and two months to arrive. Lastly, the “prices paid” components of the leading PMIs do not signal any easing of inflationary pressures. Shrinking corporate profit margins and weaker demand are the only factors likely to dampen inflationary pressures – but at the cost of a sharper slowdown in the economy.

Tensions reignite in the Middle East and oil prices see-saw

We have just witnessed a period of extreme volatility in oil prices as tensions mount in the Middle East. Fearing an imminent nuclear threat, Israel launched a wave of attacks on Iran, targeting its nuclear facilities, arms factories and top military commanders.

Oil initially surged by some 10% before wiping out all these gains on the very moderate retaliation by the Iranian army, the ceasefire announced with Israel and Iran dialling down its threats to blockade the Strait of Hormuz. The Strait is a strategic artery for oil and gas transport. Around 30% of seaborne traded oil – 20 million barrels – and 20% of liquefied natural gas flow daily through the Strait – more than 80% of it headed for Asia. While it cannot be ruled out, a proactive move by Iran to block the Strait would be counter-productive for the country, especially on the diplomatic front, since it could well draw a backlash from China, its biggest customer for oil.

Still, markets are less concerned about a disruption to Iranian production, since excess production in OPEC countries, which is estimated at 5 million barrels per day and primarily concentrated in Saudi Arabia could easily come on stream to cushion the shock. Iran produces around 3.2 million barrels of oil per day, or 3% of global output, and exports between 1.5 and 2 million barrels per day.

Worrying US public finances

Rating agency Moody’s has downgraded its credit rating on the US, joining S&P and Fitch Ratings in stripping the world’s leading economy of its top AAA rating, reflecting the lowest credit risk. The move by Moody’s comes on concerns about rising government debt. Interest payments have ballooned to 3% of GDP – and are set to rise still further in the decades to come if measures aren't taken to remedy the situation. Against this backdrop, ongoing negotiations to pass the budget bill – Trump’s “One Big Beautiful Bill Act” – are fuelling concerns in the markets and amongst some US politicians, including in the Republican party. The tax cuts proposed in the bill are not fully funded and would substantially widen the fiscal deficit and increase public debt, but without boosting growth. A study by Yale research centre, The Budget Lab, expects the bill would have a negative long-term impact on the economy, add substantially to the deficit and debt and drive up long-term interest rates.

High interest rates weaken the most cyclical activities, like real estate. In the US, the property market faces headwinds amid high long-term interest rates over the past 12 months. 30-year fixed mortgage rates are hovering around 7%, adding to affordability problems for homebuyers. Unsurprisingly, persistently high rates have also eroded home builders’ confidence, taking it to its lowest level since the end of 2022.

Source: NAHB, Banque de Luxembourg

The Fed waits. The ECB cuts

Amid heightened uncertainty, the US monetary authorities were unanimous in their decision to hold headline rates unchanged at 4,25% - 4,5% in a widely anticipated and justified move. However, the expected slowdown in the economy would prompt the Fed to start loosening US monetary policy. Markets are now pricing in practically two rate cuts by the end of the year.

In the eurozone, the ECB again lowered its headline rates, cutting its key deposit rate by 25 basis points to 2%. In May 2024, it was 4%. In its statement, the Central Bank said it was well positioned to deal with the current conditions of exceptional uncertainty and expressed confidence with how prices were trending. It expects inflation to return to 2% in 2025, 1.6% in 2026 and 2% in 2027. The bank has maintained its outlook for 2025 economic growth at 0.9% and lowered its forecast for 2026 and 2027 to 1.1% and 1.3% respectively. Given the resilience of European leading indicators, most of the downward movement in rates is now behind us, for now.

Damien Petit, Head of Private Banking Investment,
Banque de Luxembourg