The global economy will see its slowest growth in 2025 since the Covid pandemic. New U.S. trade policy created a structural shock to the world’s economy, with the uncertainty generated by higher tariffs crimping demand globally.
Morgan Stanley Research forecasts the global economy will expand at an annual rate of 2.9% in 2025 (2.5% 4Q/4Q) and 2.8% in 2026, down from 3.3% (3.5% 4Q/4Q) in 2024. This scenario assumes that the U.S. will continue trade negotiations but will not fully eliminate tariffs.
“The economic damage is underway, and even fully undoing the tariffs would not restore global growth to where it would have been without them,” says Seth Carpenter, Morgan Stanley’s Chief Global Economist. “Conversely, a re-escalation of tariffs to April’s peak rates would likely spell a recession for the U.S. and thereby the world. We expect higher barriers on trade overall than in the beginning of the year, with high risk of temporary re-escalation with key trading partners as negotiations reach sticking points.”
Central Banks and Fiscal Policy
Inflation is likely to continue losing steam globally except for the U.S., slowing to 2.1% in 2025 and 2% in 2026, from 2.4% in 2024. Weaker demand, currency appreciation and lower oil prices are driving the slowdown in consumer prices.
With lower inflation and slower growth, central banks could be more inclined to reduce interest rates. The U.S. is again an outlier, with the Federal Reserve likely to hold rates steady until March 2026.
The U.S., the euro area and China are likely to increase government spending to support their economies, leading to an increase in public deficits. Germany’s deficit could rise to its highest level since its 1990 unification as the country invests in infrastructure and defense. In the U.S., rising interest costs are also driving up the deficit.
U.S. Growth and Inflation
After growing 2.8% in 2024 (2.5% 4Q/4Q), U.S. economic growth is likely to slow to 1.5% (1% 4Q/4Q) this year and 1% in 2026.
“Immigration restrictions and policy uncertainty add to tariffs’ drag on U.S. growth, and we are skeptical of meaningful support from fiscal policy or deregulation,” says Michael Gapen, Morgan Stanley’s Chief U.S. Economist.
Inflation is likely to accelerate and reach a 2025 peak between 3% and 3.5% in the third quarter as companies pass some of their tariff-related costs through to customers. Additionally, restrictions on immigration could contribute to labor shortages and lead to inflation in services. Consumer prices should begin to slow in 2026 amid weaker demand and lower business spending.
The Fed funds rate should remain unchanged until March.
“Tariffs tend to boost inflation before slowing growth, so the Fed will likely worry more about containing inflation than maintaining employment until late this year, when inflation peaks and begins to decline,” Gapen says. “After inflation starts to fall, the labor market should continue to deteriorate. At that point, we think that the Fed will cut rates past neutral and end up with 175 basis points in cuts by the end of 2026.”
Continued Easing for the ECB
In the euro area, the main obstacle to growth is lower exports.
Europe’s economy is likely to expand 1% in 2025 (0.8% 4Q/4Q) and 0.9% (1% 4Q/4Q) in 2026, after growing 0.8% last year (1.2% 4Q/4Q), while inflation should fall below the European Central Bank’s target in the course of 2025 and remain there afterwards.
“Falling inflation, weak growth and a stronger euro make the decisions for the ECB easier,” says Jens Eisenschmidt, Morgan Stanley’s Chief Europe Economist. “We forecast that the ECB will continue its easing cycle, bringing the policy rate below neutral to 1.50% by December 2025.”
China’s Bumpy Growth Journey
In China, government measures to support the economy are unlikely to offset the negative impact of U.S. tariffs. The country also faces deflationary pressures and continuing weakness in its housing sector.
The economy should grow 4.5% in 2025 (4% 4Q/4Q) and 4.2% in 2026, slowing from 5% in 2024 (5.4% 4Q/4Q).
“Some pockets of the economy may outperform with government support, such as certain consumption goods, capital expenditures for urban renewal and technology,” says Morgan Stanley’s Chief China Economist Robin Xing. “However, broader reflation should remain a long and bumpy journey as China addresses its debt and economic imbalance.”
The Domestic Demand Buffer for India and Japan
In Japan, the steady rise in base pay and the inflation deceleration are likely to lead to an improvement in real incomes and consumer confidence. These tailwinds for private consumption could help provide an offset to the headwinds from abroad, sustaining economic growth of 1% this year (0.3% 4Q/4Q) and 0.5% (0.6% 4Q/4Q) in the next, above 0.2% growth in 2024.
“Within the region, we see India as being best placed given its low goods exports to GDP ratio at the starting point. The country will remain the fastest-growing economy,” says Chetan Ahya, Morgan Stanley’s Chief Asia Economist. “Domestic demand is recovering, the structural uptrend in services exports remains intact and the macro policy stance is supportive of growth.”
India is likely to grow 5.9% in 2025 and 6.4% in 2026, after an expansion of 6.2% last year.
Mexico Growth Stalls, Brazil Slows
Mexico will likely stall this year and resume expansion in 2026. Besides the tariff effects and the country’s close connection to the U.S. economy, government spending remains a drag on growth and domestic demand is still weak with a deteriorating labor market.
“Elevated uncertainty is already affecting growth and will likely persist at least until mid-2026, the deadline for the renegotiation of the trade agreement with the U.S. and Canada (USMCA)”, says Fernando Sedano, Morgan Stanley’s Chief LatAm Ex-Brazil Economist. “The sizeable deceleration in U.S. activity is also a headwind to Mexico's exports, investment, consumption, and overall growth. We struggle to find growth drivers during the forecast horizon.”
Brazil, the largest economy in Latin America, is likely to grow this year and in 2026, but at a slower rate. The primary headwinds for the country’s economy are its very high interest rates, weakening wages and subdued investment ahead of elections in 2026.
