A view from London

This doesn’t mean that the world has shrugged off the effects of tariffs. The impact of tariffs on growth and inflation takes many months to feed through the system. Five months on from Donald Trump’s ‘liberation day’ announcement, we still don’t have a full picture of US tariff rates by country and product. The next key date is 10 November when a pause in the application of the highest US tariffs on China ends. The jury is still out on how America’s tilt towards protectionism will affect the global economy in coming years. 

What is clear is that tariffs have hit prospects for US growth harder than for most other countries. Economists slashed their forecasts for US growth since January and expect the economy to grow by 1.6% this year, just over half last year’s rate and the slowest pace of growth since the pandemic.

Hopes about the transformative effects of AI have ridden to the rescue, buoying sentiment and boosting US equities. That has fed through to a surge in investment in AI and data centres which has buoyed US growth. Were it not for tech – and a strong performance from the healthcare and real estate sectors – US activity would be faltering.

Two areas of concern are lacklustre levels of consumer confidence and a rapidly weakening jobs market. US inflation is drifting higher, partly as a result of the imposition of tariffs, adding to the squeeze. Barring a sharp pickup in the August inflation data on Thursday, we expect the Federal Reserve to cut interest rates when it meets next week.

What of China? The world’s second-largest economy saw a boost to demand from stockpiling ahead of the application of US tariffs. While trade with the US has fallen sharply trade with other countries continues to grow. It is a measure of the resilience of China’s economy that the IMF has raised its forecast for GDP growth this year from 4.0% in April to 4.8% in July, similar to last year’s 5.0% rate.

Momentum in the euro area is mildly positive. GDP forecasts for this year have been revised up since the spring, high-frequency data points to a gentle increase in activity and the ifo survey of German business confidence – one of Europe’s most important economic indicators – has risen steadily through this year.

The most obvious sign of increased confidence in Europe can be seen in stock markets. Euro area equities are up 27% so far this year while the UK is up 14%, both stronger than the US (11%). Higher spending on infrastructure and defence in Germany and an increased focus on growth-boosting reforms across the continent have helped boost sentiment. Expectations for euro area corporate earnings, too, have risen 13% since the start of the year. European equities trade at lower earnings multiples than in the US, making them attractive to investors concerned about exposure to the US technology sector and broader volatility in the US economy and the dollar.

The UK’s had a good year so far with the economy growing by 1.1% in the first half, making it the fastest-growing economy in the G7. One-off factors such as tariff-related stockpiling and the end of the stamp duty holiday have flattered the GDP numbers and we expect the pace of UK growth to slacken in the second half of the year.

The UK is an outlier in another, less desirable area, with inflation rising to 3.8% in July, higher than any other G7 economy. This has created a headache for the Bank of England, which is weighing the risk of above-target inflation against a weakening jobs market. Unemployment, at 4.7%, is at the highest level in over four years while HMRC data show that the number of payrolled jobs has been on a downward trend since last autumn.

The Bank has cut the UK base rate from a peak of 5.25% to 4.0%. Financial markets are pricing only one further rate cut in the spring of next year and an approximately even chance of one further final cut later in 2026.

Higher inflation has contributed to an upward drift in the yield, or interest rate, on UK government bonds, a process that has been exacerbated by weakened demand for long-dated gilts from defined benefit pension schemes. Last week the yield on 30-year gilts reached a 27-year high. Ten-year borrowing costs are higher than elsewhere in the G7.

This is adding to the difficulties facing UK chancellor Rachel Reeves, who is widely predicted to face a shortfall in tax revenues if she wishes to meet both her current spending plans and fiscal rules. One estimate from the National Institute of Economic and Social Research put the shortfall at £50bn if the chancellor wants to maintain the current level of fiscal headroom. The Autumn Budget will take place on 26 November and it seems inevitable that speculation over tax rises will continue until then, with potentially harmful effects on consumer and business sentiment.

The UK is far from alone in facing difficulties over its budget. French prime minister Francois Bayrou looks at risk of losing a confidence vote today as he seeks to find €44bn in spending cuts, including, among  other things, scrapping two public holidays.

In a warning shot to the public and his coalition partners Germany’s chancellor Friedrich Merz said last month that “the welfare state that we have today can no longer be financed with what we produce in the economy”.

Japan, Italy and Canada have also seen their borrowing costs rise this year. A notable exception is the world’s largest and most liquid debt market, that for US Treasuries where ten-year bond yields have slightly declined since the start of the year.

As well as Mr Trump’s tariffs announcements was the passage of his budget bill. It includes $4.1tn in tax cuts over the next ten years, but with only limited spending cuts, is set to add $3.3tn to federal deficits.

Mr Trump has continued to criticise Fed chairman Jerome Powell and last month attempted to fire Fed governor Lisa Cook. This has raised concerns that the independence of the US central bank, seen as a key safeguard against political interference and inflation, may be at risk.

Against a backdrop of growing worries about government debt and higher inflation investors have sought out supposed safe-haven assets. The dollar price of gold hit a fresh high just last week and has risen by 35% this year. Bitcoin also hit a record high last month and is up 20% since the start of the year. The US dollar has been a casualty of recent developments and has fallen by about 9% this year.

The world economy has managed to avoid some of the negative outcomes that seemed quite likely earlier in the year. But we are not out of the woods. The full impact of tariffs is still to be felt and US growth, like the US stock market, is heavily dependent on tech.  Concerns around government indebtedness and geopolitical risk are here to stay. The tectonic plates of public opinion are shifting in Europe, with Reform UK 11 points ahead in polls in the UK, Rassemblement National 6 points ahead in France and Alternative für Deutschland 1 point behind the CDU in Germany.