2025 Midyear Economic Outlook: A widespread deceleration

• Global growth is set to weaken to an average annual rate of 2.9% this year (or 2.5% in the fourth quarter), as US deceleration weighs on the rest of the world.
• Inflation is likely to slow in most countries, except in the US, where tariffs may increase consumer prices to a peak in the third quarter.
• Central banks could react to lower growth and inflation with rate cuts, except for the US, where rates are likely to remain steady until March 2026.
• Governments in the US, Europe, and China may spend more to stimulate growth, increasing their deficits.

The global economy will see its slowest growth in 2025 since the Covid pandemic. New US 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 US 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 US 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.” 

Inflation is likely to continue losing steam globally except for the US, 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.¹

With lower inflation and slower growth, central banks could be more inclined to reduce interest rates. The US is again an outlier, with the Federal Reserve likely to hold rates steady until March 2026.  

The US, 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 US, rising interest costs are also driving up the deficit.

After growing 2.8% in 2024 (2.5% 4Q/4Q), US economic growth is likely to slow to 1.5% (1% 4Q/4Q) this year and 1% in 2026.1  

“Immigration restrictions and policy uncertainty add to tariffs’ drag on US growth, and we are skeptical of meaningful support from fiscal policy or deregulation,” says Michael Gapen, Morgan Stanley’s Chief US 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 2026.  

“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.”

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. ¹

“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.” 

In China, government measures to support the economy are unlikely to offset the negative impact of US 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).¹

“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.”

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 2024.¹

“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.¹

Mexico will likely stall this year and resume expansion in 2026. Besides the tariff effects and the country’s close connection to the US 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 US and Canada (USMCA)”, says Fernando Sedano, Morgan Stanley’s Chief LatAm Ex-Brazil Economist. “The sizeable deceleration in US 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.  

When considering which investments may fit into your portfolio, be sure to keep in mind individual goals, timelines, and risk tolerance.

Article Footnotes

¹ This article by Morgan Stanley Research was originally published on May 28, 2025, as the “2025 Midyear Economic Outlook: A Widespread Deceleration.” It is based on Morgan Stanley Research’s 2025 Midyear Global Strategy Outlook titled “Global Economics Mid-Year Outlook: Skewed to the Downside.”

CRC# 4544539 06/2025

For a weekly recap of the markets and thoughts on the week ahead, visit our weekly Market Dashboard.