Spain –2025-2026 Scenario: dynamic growth in an uncertain environment
The Spanish economy began 2025 with greater momentum than its European partners. In 2024, GDP grew by 3.2%, increasing by 0.8% in Q4, supported by consumption and investment. The fundamentals are solid: a current account surplus for the 13th year, private debt limited to 125.1% of GDP (vs. 153.5% in the eurozone) and public debt down to 101.8%. The net international investment position also improved. This strong performance served to increase the growth forecast to 2.5% in 2025. The recovery remains concentrated on domestic demand. Lower interest rates, disinflation (inflation is expected to be 2.5% in 2025) and a high savings rate should boost consumption. Employment is set to increase by 2% and unemployment is forecast to fall to 10.9%.
Despite this favourable environment, foreign trade is expected to have a negative impact, due to dynamic imports and slowing exports. Geopolitical and trade tensions (US-EU) represent a significant risk. The full deployment of NGEU funds will be important in maintaining the momentum of private investment.
South Korea: what with fires, martial law and trade tariffs, the Year of the Blue Snake has not had the most auspicious start
Five months to the day after martial law was declared1, South Korea’s Constitutional Court upheld the impeachment of President Yoon Suk Yeol, paving the way for fresh elections on 3 June. Released at the beginning of March as a result of a procedural irregularity after spending two months behind bars, Yoon Suk Yeol is not yet in the clear: he still faces charges of insurrection, abuse of power and obstruction – crimes punishable by the death penalty. So, while the first season of this K-drama, marked by “unconstitutional and illegal acts […] constituting a serious violation of the law”, is drawing to a close, it looks set to be followed by a trial without precedent in the history of South Korea.
The presidential election campaign looks set to be intense, perhaps even violent. While the 2022 campaign already highlighted division, notably along age and gender lines, the events of the past four months have divided South Korean society even more profoundly, with many calling for Yoon to be removed while others demand that he be reinstated.
The front runner is Democratic Party candidate Lee Jae-myung, who lost out to Yoon in 2022 and who is himself under investigation in connection with a property development scandal during his stint as a mayor. The conservative People Power Party, trailing in the polls, has yet to find a candidate.
With the interim period marked by a succession of twists and turns (including heated discussions over the appointment of justices to achieve a quorum on the Constitutional Court, Yoon’s tumultuous arrest and subsequent release, the impeachment and subsequent rehabilitation of acting President Han Duck-soo and Lee Jae-myung’s acquittal in one of his legal cases), South Korea is going to need a president with authority to face whatever lies ahead.
The bad news has been piling up since December: first there was the martial law incident, then intense fires – the worst in the country’s history – claimed around 30 lives and exposed serious shortcomings in the authorities’ ability to combat this type of catastrophe. But the coup de grâce came from the United States, with President Trump announcing a 25% tariff on all imports from South Korea (with the exception, for the time being, of semiconductors). The automotive sector – one of South Korea’s top exporters to the US – was also hit with a special 25% tariff. News of a 90-day pause in these tariffs is a welcome reprieve and will give South Korea some time to negotiate, if the tariffs really are to take effect.
Despite being hampered by domestic political upheaval, which is limiting the acting president’s room for manoeuvre, South Korea is in a rather better negotiating position than most of its neighbours. Trump himself has cited the country, together with Japan, as one of those most likely to reach a deal in the coming days.
South Korea, which for the time being has opted to negotiate rather than hit back, has a number of options at its disposal. The first is to increase its imports of American products, including in particular liquefied natural gas (LNG). The US already became the country’s leading supplier of LNG in 2024 (with imports worth $7.5 billion), ahead of Australia and Qatar. But there is scope for it to buy more. The same goes for oil, South Korea’s number one import.
The second option relates to shipbuilding. With Donald Trump still threatening to tax freight companies that use Chinese-made vessels or have vessels on order in China, South Korea is a partner of choice when it comes to standing up to Chinese competition. US shipbuilding group HII recently signed a memorandum of understanding with South Korean group HD Hyundai Heavy Industries to step up military and commercial shipbuilding. America’s shipbuilding industry, which has declined substantially, notably as a result of Chinese competition, could revive itself with the help of South Korea’s shipbuilding sector.
The third potential avenue for cooperation is in the military domain. With a number of US military bases in South Korea, Trump has said several times that the country should pay to continue to benefit from this US presence, which acts as a deterrent, notably against North Korea. While no amount has been disclosed thus far, South Korea could agree to contribute more to the costs of stationing and maintaining US forces on its territory.
Lastly, more and more South Korean firms have announced investments in the US since 2020. Investment inflows have mainly been concentrated in the strategic semiconductor, electric vehicle and battery sectors, driven by industrial policies put in place by the Biden administration such as the Inflation Reduction Act and the CHIPS and Science Act. The introduction of import tariffs in the automotive sector could prompt some manufacturers to expand their domestic footprint. Hyundai recently announced new investments totalling $21 billion, including a steel mill in Louisiana whose output could be used to make electric vehicles.
Markets reacted with relief to the Constitutional Court’s ruling, which, while it has not completely ended the turbulence unleashed by the declaration of martial law in December, has at least made it possible to chart a way forward and set out a clear calendar for the coming months. This relief was quickly overshadowed by the storm over US trade tariffs, which sent the South Korean stock market – like all its Asian counterparts – into a tailspin.
If the candidate standing for the Democratic Party, whose line is traditionally more pro-China than the conservative People Power Party, were to win the election, would this drastically change the country’s negotiating strategy, particularly if any deal were to include a military element? With the campaign yet to be officially launched (the parties must first hold primaries to nominate their candidates), the main issues around which it will revolve are not yet known. However, it seems likely that South Korea, like the rest of Asia, will be guided first and foremost by a highly pragmatic approach to trade and will seek to protect as far as possible the interests of its export sector, at the heart of its economic model.
Even as South Korea negotiates with the US, tripartite talks have also resumed with China and Japan with a view to expediting the signing of a “comprehensive and equitable” trilateral free trade agreement. These talks, which began in 2013, were suspended in 2019 before resuming in 2024. While the three countries are already members of the Regional Comprehensive Economic Partnership (RCEP), this agreement would be broader and would include an investment component. China, South Korea and Japan, which together account for around 20% of global trade, have also emphasised the need to protect the multilateral trade system.
South Korea is walking a tightrope: moving too close to China could also be seen by the US as a provocation. In this extremely volatile global environment, it urgently needs a new leader who can set a strategic course, whatever it may be, and embody the country’s interests.
To find out more, see our articles Following his failed power grab, South Korean President Yoon escapes impeachment, dated 12 December 2024, and South Korea: K-drama in Seoul, dated 23 January 2025.
Eurozone – 2025-2026 Scenario
A transatlantic rift has opened. It had been incorporated into our forecast last December in the form of a downward revision to growth to take account of the negative impact of the rise in tariffs on steel and aluminium to 25%, as well as an alignment of the average US tariff with that of the EU. into a downward revision to growth of 0.2 percentage points (pp) as a direct result of lower exports and a further 0.1 pp as a result of increasing uncertainty over investment decisions.
The increase in customs duties on vehicles to 25% has been integrated into this March 2025 scenario; this increase would result in an 8% drop in automotive production in Western Europe with a drain on Eurozone growth of -0.1 pp in 2025. But Europe has also committed more spending on infrastructure investment and on the military, the impact of which offsets the negative effect of US policies, bringing the zone's growth to 1% in 2025 and then to 1.5% in 2026.
The tariffs introduced on 2 April (Libération Day) are therefore not included in our central scenario, but their impact has been quantified in a risk scenario. Assuming no symmetric retaliatory measures from the EU, this scenario introduces a further 0.1 pp decline in GDP growth in 2025, 0.3 pp in 2026 and 0.2 pp in 2027 for the Eurozone.
World – 2025-2026 Scenario
The contours of the "new world" are clearly taking shape: domination by force at the expense of the rule of law and multilateral institutions, trade wars replacing the now-defunct globalisation, fragmentation/regionalisa¬tion of trade flows. The paths that lead to this new territory, the paths that usually enable us to draw up economic scenarios over a shorter horizon, are chaotic. In particular, they are distorted by US trade obsessions: tariffs so high that they almost look like threats, dates for the implementation of sanctions announced and then postponed, hopes for negotiations, expected retaliation from targeted countries, and so on. The versatility and excessiveness of the US administration’s threats are such that their victims move from uncertainty, which is already highly penalising, to a state of stupefaction, obliterating their ability to think, anticipate and react.
Stupefaction is precisely what Donald Trump's tariff announcements on “Liberation Day” produced. Firstly, because the tariffs – which Trump claims are sucking the life out of the US economy, are perplexing when compared with what is actually applied. Secondly, because the tariffs announced (including the strangely calculated reciprocal tariffs) exceed what had been anticipated and are likely to be further tightened. Finally, because we had just completed our quarterly scenario…
The scenario's figures may be amended once the definitive trade provisions (US measures and retaliation by other major countries) have been decided, but its credo remains that the cost of protectionism is already high and could get even higher. Its first extra cost, in the form of additional inflation, justifies the drop in US growth forecast for 2025.
In the US, since the beginning of the year, the market has radically altered its stance, with the strong belief in ‘American exceptionalism’ giving way to heightened fears about growth. Back in December, our scenario was based on a policy timeline conducive to a US slowdown by mid-2025. It still assumes that punitive policies (tariffs and immigration restrictions, implemented by executive order) will be applied before pro-growth measures such as tax cuts, which require Congressional approval. In essence, the overall policy mix is tilted slightly towards growth. More precisely, as it stands, before the full application of the 2 April announcements, our scenario envisages growth of 1.7% in 2025, a clear slowdown from the 2.8% posted in 2024 and a slight downward revision of our December 2024 forecast (1.9%). This slowdown is accompanied by inflation close to 3% at the end of 2025.
In response to the declaration of trade war, Europe has not disarmed. A transatlantic rift has opened up. This rift had already been incorporated in the form of a double negative impact: higher tariffs and increased uncertainty, taking a total of 0.3ppt off the Eurozone’s growth rate. The latest round of tariffs included in the scenario (25% tariffs on automobiles) takes off a further 0.1ppt. But the promising European response in the form of infrastructure investment and military spending, and above all the German tax package, would bring additional growth to the Eurozone, which is currently expected to reach 1.0% in 2025 and 1.5% in 2026 (compared with 1.2% previously). The intensification of the trade confrontation with the US, not included in our central scenario, poses a downside risk on both sides of the Atlantic.
After “Liberation Day”, the Fed will be faced with an even more perilous balancing act. It will have to combine support for weakened growth, while rising inflation is the first risk to the US economy brought on by tariffs. The Fed could end up relaunching its rate-cutting process, but with limited easing, with two further 25bp cuts in June and September, before entering a prolonged pause with the Fed Funds rate upper bound at 4.0%. However, the risks are tilted to the upside: it would be no surprise to see the Fed cut rates less than twice in 2025.
As for the ECB, the depressive impact of US tariffs is countered by the prospect of stronger growth due to the German package. Against a backdrop of immense uncertainty, the ECB is obliged to be cautious: with a certain amount of audacity, our current scenario only includes one 25bp cut in June followed by a long pause, with a deposit rate at 2.25%, and the maintenance of quantitative tightening. Unlike the US, the risk is rather bearish, with the possibility of a cut in April: this bias is maintained.
Interest rates are supposed to bet early on the promise of growth: an assumption that should be maintained. While monetary easing appears to be nearing an end, the second phase of Trump's economic policy, presumed to be favourable to growth, and hopes of European momentum boosted by German public spending, remain conducive to a gradual rise in interest rates.
In the US, in the absence of any risk of a hard landing, it is unlikely that the 10Y Treasury yield will fall below 4.0% for long. If we base our interest rate forecasts on the monetary scenario and the tempo of economic policy measures, the 10Y UST would fall until mid-year, before firming up in H225 (to 4.45% by the end of 2025) and in 2026 (to 4.75% by the end of 2026). In the Eurozone, Germany's change in fiscal policy means that we can expect the German 10Y Bund yield to reach 3% by the end of 2025 (ie, almost 20bp above the swap of the same maturity) and major countries to tighten Bund spreads. France, Italy and Spain would offer spreads of 60bp, 105bp and 55bp respectively above the Bund at the end of 2025.
Finally, on the USD front, the “Trump trades” did not last long. While Trump's election was favourable to the USD’s appreciation, it all went south after Inauguration Day: the speed of its depreciation since the start of the year has come as a surprise. The USD is likely to remain under pressure, particularly if concerns over the "Mar-a-Lago accord" are revived: the EUR could thus appreciate and peak at USD1.12 by the end of 2025.
Completed on April 3 2025
The main assumptions of the scenario and associated pricing, including growth and inflation, were finalized on March 31, 2025.
China: will the change in the authorities’ rhetoric be enough to restore confidence?
There can no longer be any doubt: the Chinese authorities have changed their rhetoric. Although this change has yet to filter through into meaningful measures of any significance, it has already succeeded in making markets – which had given up hope of a stimulus plan they had been waiting for since the end of the Covid pandemic – sit up and take notice. Whereas Chinese public policy has traditionally targeted supply, notably through various forms of support for businesses (grants, tax credits, access to liquidity), and Xi Jinping used to regularly slam “welfare societies” where the welfare state and Keynesian mechanisms play a role, this shift in tone means there is now more emphasis on domestic consumption and demand.
Last week, the Chinese authorities announced a plan to “vigorously boost consumption” – something they had already made a priority during the parliamentary sessions in early March, when the ambitious 2025 growth target of 5% was confirmed.
Markets have enthusiastically welcomed this new plan, with Chinese stocks – chiefly in the tech sector – still buoyed by the “DeepSeek effect”. With support for the private sector in evidence at the highest levels of government, notably with Jack Ma restored to favour and received by Xi Jinping in person, markets want to believe that China has put economic growth back at the top of its priority list.
If we take a closer look, however, we can see that this change in rhetoric also reflects real and justified concerns on the part of the authorities, which are well aware that the consumer confidence crisis is deep and lasting and that hardening external conditions – starting with higher US trade tariffs – risk jamming up China’s most powerful growth engine.
However much the authorities might have asserted their desire since 2015 to rebalance the growth model away from investment and towards consumption, with the aim of also reducing the country’s reliance on the outside world, this rhetoric has not really been reflected in public policy. In fact, investment as a percentage of GDP even rose after Covid. This time around, the government appears keen to explore more specific ways to revive still sluggish consumer spending.
Firstly, the government has extended its consumer goods trade-in programme (covering phones, TVs and small appliances), for which a budget of 300 billion yuan (around $40 billion) has been set aside. Secondly, the minimum wage has been raised following the increase in civil service wages in December and social security coverage has been expanded to cover some insecure jobs, including in particular delivery workers and migrant workers. Lastly, the government has announced childcare subsidies with the aim of also supporting a rapidly shrinking population: with the fertility rate averaging around 1.1 children per woman, China’s population declined for the third year running in 2024.
But will this be enough to restore to Chinese households the desire and the confidence they need to spend? The Covid crisis seems to have hit consumers so hard that nothing could be less certain. In January and February, retail sales were up 4% year on year – a thoroughly respectable performance, slightly ahead of consensus expectations. But that 4% came at a high fiscal and monetary cost – the cost of state subsidies to encourage households to buy consumer goods and, above all, an across-the-board fall in prices reflecting a return to deflation (with prices down 0.7% year on year in February). This is a steep price to pay to see consumption grow slower than overall economic growth, raising questions as to the effectiveness and sustainability of these measures. In 2024, 25% of Chinese companies reported losses. Without government support, and with margins squeezed and a price war raging, the correction in corporate earnings could be even more severe.
Chinese households are still worried: the real estate sector has shown no real sign of recovery and new home construction volumes even began to fall again in February. With the bulk of Chinese assets invested in real estate, a modest improvement in stock valuations is not going to be enough to convince people to invest their savings in markets where financial savings solutions are still comparatively undeveloped relative to the pool of potential investors.
Here again, the government has come to the sector’s rescue. With private developers swept away by the crisis, public sector stakeholders have never played such a key role in transactions, as either buyers or project developers. Over 50% of private developers have gone bust since 2021, leaving local authorities and state-owned enterprises in the front line to take over projects, buy vacant or unfinished properties and oversee a drop in prices, which official statistics say remain stubbornly high.
On top of all this, there are now worries over the American position on trade tariffs. The US administration has already implemented two 10% hikes, in February and March. China has responded cautiously, targeting increases of between 10% and 15% on certain categories of goods (mainly agricultural products and energy). And, with the US president having already pointed his finger at the weak yuan, calling it “unfair” to the United States, Beijing is also taking care to ensure the stability of its currency by limiting its depreciation. This could perhaps leave the door open to potential negotiations, though Donald Trump appears to be in no hurry to negotiate: while he has expressed a desire to meet with his Chinese counterpart in the “not too distant future”, a specific date has yet to be put forward. And, while China is not the country most affected by reciprocal tariff moves due to be outlined in early April, it could find itself the target of fresh tariffs: during the presidential election campaign, Trump promised 60% tariffs on all US imports of Chinese goods.
Chinese exports were down 3% year on year in February. This is not yet a major concern: Chinese exports to the US soared in the run-up to the end of 2024 in anticipation of higher tariffs. Seasonal effects to do with the exact timing of the Chinese New Year (which sometimes falls entirely in February and sometimes straddles January and February) may also be a factor.
The fact remains that Chinese exporters are bracing themselves for some tough months ahead, especially bearing in mind that the measures announced by the US could also trigger indirect effects by prompting other countries to erect tariff and/or non-tariff barriers to protect themselves against a wave of Chinese products. While China has said it wants to reduce overcapacity in some sectors, notably steel and aluminium, its room for manoeuvre is limited: it has its own domestic constraints to manage in terms of employment and social stability.
The change in rhetoric indicates that the Chinese authorities are taking seriously signs that their model is running out of steam as it reaches limits well known to emerging economies that have paid too little attention to balancing and distributing the benefits of growth to create a consumer middle class that can support demand without external help. It remains to be seen precisely what measures and resources will be put on the table to restart the engine of consumption, and how much capacity local governments – unquestionably in the front line in this area – will have to implement those measures at a time when they are already having to manage another legacy of this unbalanced growth model: the deleveraging and rationalisation of some 12,000 financial platforms used to finance infrastructure programmes.
France: Banque de France says slightly lower growth and inflation in 2025 and 2026
The Banque de France has published the findings of its start of March Monthly Business Survey as well as interim macroeconomic projections. As was the case the previous month, the survey suggests positive but weak first-quarter growth of between 0.1% and 0.2%. Compared with its most recent medium-term forecasts (December 2024), the Bank has downgraded its growth forecasts for this year and next year to 0.7% and 1.2% respectively. It has also cut its average annual inflation forecast to 1.3% this year and 1.6% next year (based on the Harmonised Index of Consumer Prices, HICP). Forecast unemployment remains unchanged, rising to 7.8% in 2025 and 2026.
The findings of the Banque de France Monthly Business Survey – Start of March show that industrial activity continued to grow in February, contrary to last month’s expectations. Conversely, there was little growth in market services and construction. Business leaders expect modest growth in market services in March but little growth in industry and construction. There is some good news: after rising the previous month, the monthly uncertainty indicator has declined in market services and even more so in construction. The Bank puts this decline down to the fact that the French Government has now passed a budget. However, the indicator remains unchanged in industry, with manufacturers citing the international environment as the number one driver of uncertainty, with particular concerns about US import tariffs in sectors such as metalworking, metal products and capital goods. Survey responses also suggest that selling prices and recruitment difficulties continue to normalise.
In light of elements derived from its survey, which it traditionally supplements with other short-term economic indicators, the Banque de France anticipates first-quarter growth of between 0.1% and 0.2%, unchanged from last month. Added value is expected to be driven by market services (after the boost from the Paris Olympic and Paralympic Games washed out in the fourth quarter of 2024), agriculture and energy while holding steady in manufacturing industry and construction.
In its March interim macroeconomic projections, the institution downgraded its growth and inflation forecasts for the next two years. It now expects GDP to grow by 0.7% this year (compared with 0.9% in its December 2024 projections) and 1.2% in 2026 (previously 1.3%). Looking at the detail, the 2025 downgrade is a result of the decline in the contribution of changes in inventory to growth (down 0.2 percentage points/pp), probably as a result of overhang effects. The 2026 downgrade is due to lower growth in investment and public consumption.
As regards inflation, the Banque de France has also downgraded its average annual forecasts for 2025 and 2026 to 1.3% (down 0.3 pp) and 1.6% (down 0.1 pp) respectively, based on HICP. These downgrades are a result of weaker core inflation (i.e. excluding energy and food), revised down 0.4 pp to 1.8% in 2025 and 0.1 pp to 1.8% in 2026. In particular, wage growth was slower than forecast in 2024 (with growth in the average per capita wage coming in 0.3 pp lower than expected, at 2.5%) and is also set to be less buoyant than originally forecast in 2025 (0.4 pp lower at 2.4%), which means services inflation should slow more sharply than previously expected.
Net job destruction should be lower in 2025 than the Bank’s December forecast after stronger growth in employment in 2024. However, forecast average annual unemployment rate remains unchanged and is set to rise to 7.8% for the whole of France in 2025 before stabilising at that level in 2026.
The Banque de France’s forecast takes into account the 10 pp increase in US import tariffs on Chinese goods and China’s retaliatory measures (with a minimal impact on France). However, it does not take into account higher tariffs on imports from Canada, Mexico or the European Union (EU). Uncertainty arising from these measures is, however, factored in, with a negative impact on economic activity in France (reducing 2025 GDP by 0.1 pp). Nor does the forecast take into account the European Commission’s announcements on increased military spending or measures being debated in Germany. Domestically speaking, the Bank has factored in the effects of the 2025 Budget Act passed on 14 February. The forecast is fraught with uncertainty. Risks remain mainly to the downside on growth (potential US tariff hikes and European responses). However, higher military spending constitutes an upside risk to growth at the end of the forecast horizon.
The Bank has endeavoured to quantify the risk associated with trade tariffs, modelling the impact of a 25 pp hike in US import tariffs on goods from the EU. Estimates produced by the ECB-Global model point to a decline in eurozone GDP after a few quarters and a maximum impact of around -0.3% after one to two years. This includes both direct effects on European exports and the indirect effects of a slowdown in the US economy (with monetary policy in particular likely to be more restrictive) and the global economy. But the impact on European GDP and inflation will depend on how exchange rates move in response, how the EU responds, whether Chinese exports shift to the European market, and so on. In other words, there is still plenty of uncertainty. The effects on European inflation are equivocal and would in any case be limited. The economic impact on France would be lower than that on the eurozone as a whole because France’s exports are less exposed to the US market.
The Banque de France’s growth forecasts for 2025 and 2026 are fairly close to the ones built into our December scenario, with growth slightly weaker in 2025 (0.7% as opposed to 0.8%) and subsequently slightly stronger in 2026 (1.2% as opposed to 1.1%). What we find most surprising is the sharp acceleration in wages expected in 2026. Our scenario for France will be revised in the near future, with an updated version due to be published in early April.
High levels of uncertainty around international trade (US import tariffs and reprisals) and recent European announcements (potential additional military spending and a German infrastructure investment plan) mean forecasting is currently a complicated business. However, the assessment put forward by the Banque de France of the impact of a 25 pp increase in US import tariffs on European goods shows that the effect on the French economy should remain fairly limited at the macroeconomic level, though some sectors could fare worse than others. One thing is clear: if there is a trade war, we will all be losers.
Mexico: an economy endangered by US trade tensions
There has been yet another development in the trade war between the United States, Canada and Mexico. Despite the truce expiring and 25% import tariffs coming into force on 4 March, another one-month reprieve has been granted, expiring on 2 April.
Mexico has gone to considerable effort, reducing migrant flows by 66%, putting soldiers on the border, handing drug traffickers over to the US authorities and proposing to match US import tariffs on Chinese goods. The country is even considering withdrawing from the Trans-Pacific Partnership (TPP).
Mexican markets have proved relatively stable, with the peso even appreciating slightly, regaining some of the value it had lost since the US election. This reaction reflects the perception that these measures would be temporary and transactional in nature. The new one-month reprieve – first on vehicles and subsequently on all goods – has confirmed this view.
Mexican President Claudia Sheinbaum has maintained a cautious but firm stance, earning her a popularity rating of 85%. She had announced a gathering at Constitution Plaza to set out retaliatory measures but left enough time for a deal to be made, which is what ultimately happened.
With Trump’s announcements often (deliberately) contradictory, his intentions remain hard to guess: he announced a one-month delay on 26 February only to confirm the entry into force of tariffs the very next day. Markets have assumed that this is a tactic to apply pressure to help renegotiate USMCA1 in the United States’ favour. Reactions and pressure from Wall Street and US carmarkers also influenced the decision to postpone the tariffs.
Although this new truce offers some respite, the persistent threat of import tariffs is creating uncertainty that is costly for Mexico. Mexico’s goodwill and the high degree of integration of production chains between the two partners suggest that there is hope for a final deal in the form of a new USMCA. In the meantime, the uncertainty is punishing a Mexican economy that is slowing sharply: we take the opportunity to review the situation and the potential implications if import tariffs are imposed.
The Mexican economy went into recession in the final quarter of 2024, contracting by 0.6%, reducing annual growth in 2024 to 1.2%, well short of the beginning of the year forecast of 2.3%. The Bank of Mexico (Banxico) has downgraded its 2025 growth forecast from 1.5% to 0.6% because of the imposition of import tariffs.
The slowdown in the primary and secondary sectors since last summer (with industrial production down 2.6% in the second half of 2024) was exacerbated by weak activity in the tertiary sector, which had previously been supporting growth. Consumption is stagnating and confidence among businesses, and above all consumers, which was previously strong, is beginning to ebb. Growth is increasingly dependent on external demand.
The economic uncertainty is hitting investment particularly hard. Doubts over the future of free trade with the US, Mexican legal reform and high real interest rates (over 6%) are all having a severe impact. Imports of capital goods have declined, as has foreign direct investment (FDI) – which, moreover, is increasingly dominated by reinvestment rather than brand new investment. This highlights a degree of caution on the part of investors who, while they have not given up on the idea of nearshoring, are aware of the risks. Without a robust free trade agreement with the United States, the investment and growth promised in the Mexico Plan2 may not materialise.
As regards the labour market, unemployment remains stable, but job creation and real wage growth are stalling despite disinflation. Funds sent by migrants to family and friends back home in Mexico (known as remesas) are also showing signs of slowing.
Meanwhile, the economic slowdown and restrictive interest rates have helped bring inflation down to 3.6% a year, back within the target range (3±1%) for the first time since 2021 despite peso depreciation. Banxico has eased its monetary policy, cutting rates by 50 bps in February, with a further 50 bps cut expected following its 27 March meeting. The central bank is more focused on the economic environment than on supporting the peso, making a rate hike in response to US tariffs an unlikely prospect. Inflation is slowly falling but pressures remain, notably in services. However, firmly anchored inflation expectations and the most recent numbers offer some room for manoeuvre.
A major slowdown or recession could have a significant impact on Mexico’s already severely constrained public finances. The 2-3% growth forecast built into the budget, which looked optimistic back in November, looks even more so now (with Banxico forecasting growth of just 0.6%). The high deficit of 5.7% in 2024 and the refusal to take substantial steps to increase tax revenue to offset mounting spending pressures (notably for Pemex and social spending) make for an austere budget. Public investment has fallen sharply, down from 2.1% of GDP in 2023 to 0.8% in 2025, as has spending in some areas, notably healthcare3.
Markets have welcomed Claudia Sheinbaum’s pragmatism and commitment to prudent fiscal management. However, in the absence of major fiscal reform, this approach could prove insufficient. Reluctance remains high, which means the political cost would also be high. Yet without such reform, growing spending pressure could endanger Mexico’s fiscal position and heighten fears of a rating downgrade. Moody’s adjusted its outlook from stable to negative in November, while S&P maintained its stable outlook in December, highlighting Mexico’s political stability and fiscal and monetary prudence.
Mexico’s external accounts still appear robust, with a current account deficit (0.3% of GDP) comfortably funded by net FDI in 2024 (1.7% of GDP). Imports and exports rose significantly in the second half of the year, partly as a result of frontloading in anticipation of US tariffs. A similar current account deficit is forecast for 2025, with a reduction in exports – especially if the US does impose tariffs – likely to be cushioned by a fall in imports because of weaker demand. Remesas and FDI inflows are also set to continue to decline.
The imposition of 25% import tariffs on all exports ($490 billion, equivalent to a quarter of Mexico’s GDP, with the automotive sector alone accounting for $130 billion) would give rise to an additional cost of over $100 billion. Who could absorb such a cost? While depreciating the Mexican peso would be an initial mechanical response, that alone would not be enough and would bring with it collateral damage such as imported inflation.
The Mexican economy is facing significant headwinds. Uncertainty caused by internal reform and the external political and trade environment is affecting economic performance, which was already disappointing at the end of 2024. Investment (both public and private) has taken a big hit and consumption is slowing considerably. Risks remain and will be only partly offset by more accommodative monetary conditions, themselves uncertain. The high level of value chain integration and Mexico’s political goodwill suggest that there may be hope for a deal that would allow Mexico to recover and the Mexico Plan to come to fruition. This new round of negotiations will probably tend to favour the US, with more stringent local content requirements, stricter customs checks and higher tariffs on imports from Mexico (and Canada) of goods originating from China.