Economic overview 06/2025

GLOBAL OVERVIEW

Changes in the US economy

US economy was not immune to the uncertainty that was caused by tariff announcement. In April, the composite (manufacturing + services) US PMI business survey result, which is a good proxy for the US business activity, fell to the lowest level since September 2023. Consumer optimism plunged, at the same time as both consumer and business survey respondents raised their expectations of prices. The risk of US stagflation was also fuelled by the drop in US GDP in Q1, with US real GDP declining 0.2% and registering first decline in GDP since Q1 2022. 

The 0.2% drop in US GDP in Q1 was mostly fuelled by a 43% increase in imports of US companies rushed to import goods from abroad before tariffs kicked in. The key component of the US economy – personal consumption expenditures – rose by 1.2% in Q1, supporting the technical nature of a decline in US GDP. In addition to this, as US administration has softened its tone on tariffs and adjusted some of its tariff policy down (tariffs on China were dropped to 30% from 145%), US business optimism edged higher – for example, activity in US manufacturing sector returned to growth in May after stagnation in April, and was the highest since February 2025. US GDP nowcast indexes suggest that economy returned to growth in Q2, with Atlanta FED GDP Now tracking US Q2 GDP growth at +4.6% at the moment of writing this newsletter.

However, even though latest soft (surveys) and hard (statistical) data indicate that the risk of US recession has subsided, we are not out the woods yet and risks to US economic cycle remain elevated. First, latest US business surveys indicate that economic growth in Q2 is partly of technical nature, as both businesses and consumers continue to front-run tariffs and potentially higher prices of goods in the future. For example, in May input inventories in US manufacturing sector rose at the fastest pace in 18 years. While new orders in manufacturing sector rose at the fastest pace in 3 months, the primary driver of this growth is advance consumption among US consumers who continue to spend money on imported goods in anticipation of future price increases. The risk, therefore, is that we still may see another slowdown in US manufacturing activity and consumption going forward, when the advance consumption cycle comes to an end, potentially in summer 2025.

Uptick in US inflation is another risk we are closely following, as latest US business surveys indicating that US companies are increasing prices at the fastest pace since the end of 2022, with the biggest impact coming from higher input prices because of tariffs on China.

Latest comments of the US Federal reserve officials indicate that the FED remains in the wait-and-see mode in regard to rate policy and is in no hurry to cut rates immediately – as the risk of US recession has subsided and the risk of a pick up in inflation has increased. Market participants see FED cutting rates 2 times in 2025, with first cut likely coming in September (61% probability).

Euro area economy

Euro area economy gathered pace in 2025 Q1, with real GDP growing by 0.3% compared to 2024 Q4 on a seasonally-adjusted basis. In 2024 Q4 QoQ GDP growth in the euro area amounted to 0.2%. Both Germany and France managed to avoid recession (negative quarter-on-quarter GDP growth for 2 consecutive quarters) in 2025 Q1: German GDP declined by 0.2% in 2024 Q4, however rebounded by 0.2% in 2025 Q1; French GDP dropped by 0.1% in 2024 Q4 and rose by 0.1% in 2025 Q1. However, the macro environment in the euro area remains weak, which is reflected by the fact that German real GDP registered a 0% change compared to 2024 Q1, i.e. German economy stagnated on a year-on-year basis.

While euro area economic activity rebounded in Q1, the region is not out of the woods yet, as the rebound in economic activity was partly technical and driven by advanced production in manufacturing sector and advance exports to the US in anticipation of higher tariffs. What is more, interesting divergences in regard to euro area economic cycle emerged in spring 2025: EU Commission data indicates that, despite looming tariffs, optimism among euro area industrial companies continued to improve, but euro area consumer sentiment took a substantial hit after US administration announce plans to increase tariffs. For example, euro area consumer sentiment plunged to the lowest level in almost 1.5 years in April 2025. This is also true in regard to non-euro area member states as in Denmark consumer assessment of Danish economic perspectives plunged to the lowest level in history. Therefore, in the short term it was the consumers who reacted the most to tariff uncertainty instead of manufacturing sector, where confidence levels continued to climb on advance exports to the US.

The latest leading indicators for May 2025 indicate that euro area economic activity is not worsening. What is more, it seems that German economic activity is gaining strength, as the economic sentiment index in Germany rose to the highest level in almost a year (10 months) in May. German industrial confidence in May climbed to the highest level in 11 months, consumer and retail confidence also rebounded. Having said that, economic activity in Germany remains weak on a historical level, with confidence in the manufacturing sector standing at the same level which was seen at the start of Covid quarantines. However, it seems that pause in US reciprocal tariffs blew some confidence back into the euro area economy, at the same time as euro area manufacturing companies have most likely continued to boost their exports to the US during the pause in reciprocal tariffs. Another positive sign is that, most likely, we have reached and passed the peak consumer uncertainty in the euro area, as multiple EA countries reported an uptick in consumer sentiment in May, suggesting that consumers have become less worried on the impact of tariffs on the economy and labour market, which is potentially a good sign for EA retail sales activity going forward. 

Inflation and ECB policy

Important developments were also registered on the inflation front: in May 2025 headline inflation (which includes such volatile segments such as food and energy) in the euro area declined to 1.9% year-on-year, i.e. was below the 2% target of the ECB. Euro area core annual inflation, which excludes the mentioned volatile components, declined to 2.3% in May and was also very close to the 2% target set by the European Central Bank (ECB). Among the largest euro area economies, only German annual inflation stayed above 2% in May, while in Italy and Spain inflation slowed to 1.9%, and in France inflation slowed to 0.6%. The recent slowdown in inflation, relatively weak economic cycle in the euro area (and technical nature of rebound in economic activity in Q1) opens the door for further cuts by the ECB. Since the start of the year, the ECB has lowered the deposit rate by a further 1 percentage point to the 2.0% area and it is expected to decline to 1.75% at the end of 2025. Market participants expect 3 month Euribor to decline from a current level of 1.98% to 1.76% in December 2025, while 6 month Euribor is expected to drop from a current level of 2% to 1.83% in December 2025. However, while the latest forecasts continue to indicate further decline in Euribor rates, latest Euribor projections indicate that Euribor will bottom out towards the end of 2025, i.e. will stop declining. However, this will depend a lot on the US tariff policy going forward and the impact of tariffs on the euro area economy, which is still unclear given that US and EU continue their negotiations on trade.

Baltic overview

The performance of the Estonian economy has been mixed recently, as positive data mixed with negative indicators. While GDP declined by 0.3% year-on-year, there was some positivity in the data, as such sectors as ICT, real estate, manufacturing were among the biggest contributors to Estonian economy in 2025 Q1. Therefore, while on as a whole Estonian GDP decline in 2025 Q1, cyclical sectors had a positive contribution to the economy, suggesting that business cycle has clearly improved. The bad news, however, is that in May and April the economic sentiment indicator of Estonian declined, which is a potential indication that economic cycle is weakening again. Estonian industrial sentiment has stopped expanding, with Estonian industrial companies becoming more pessimistic on export orders, production expectations and employment. Consumer sentiment remains weak and stands at levels which were last seen during Covid pandemic. May and April saw a sharp drop in Estonian services sector sentiment, most likely driven by an anticipation of higher VAT rate, which will be increased from July 1st, 2025. Statistical data is indicating a visible improvement in Estonian retail sales data, with retail sales increasing by 6% in April 2025 vs April 2024. However, we think that part of the improvement in retail sales is technical and is driven by advance buying before the higher VAT tariff of 24% kicks in on July 1st, which will lead to higher prices of goods and services. 

Lithuania maintains its position as the leader in the Baltic region in terms of the strength in economic cycle. GDP expansion is supported by multiple sectors, i.e. manufacturing, retail, while we observe more signals of a recovery in real estate sector. In other words, lower lending rates are filtering through the economy. Manufacturing output in constant prices (i.e. impact of changes in prices is eliminated) is exceeding its post-Covid peak. One of the key and largest sectors of Lithuanian manufacturing – wood and timber industry – is registering a growth in production and sales after a prolonged slump, which partly supports overall increase in production. Part of growth in manufacturing is also driven by tariffs, as electronics and metal processing sectors saw a sharp increase in sales recently. Retail sales is another sector where sales have exceeded their post-Covid peak in constant prices, with growth in retail sales mostly driven by non-food segment, i.e. non-necessities, highlighting the strength of domestic demand. Lastly, we are observing a visible improvement in both year-on-year growth in new mortgage loans and amount of real estate purchase contracts, which is a good indication of a recovery in real estate sector. In addition to this, after hitting the lowest level in 1.5 years in April (impact of tariff uncertainty and tax reform), Lithuanian consumer confidence has ticked up in May, which indicates that peak consumer uncertainty is behind us, which is positive news for sectors which depend on domestic demand (retail, services, real estate). 

While Lithuania maintains its position of the leader of the Baltic region in terms of the strength of economic cycle, its high dependence on export-oriented manufacturing sector also makes Lithuania more vulnerable to tariff risks. Data from Eurostat indicates that in 2024 manufacturing sector generated 18% of Lithuanian GDP (5th highest result in EU), on par with Germany (20%), while in Latvia and Estonia the share of manufacturing in GDP stands at 10% and 12% respectively, which means potentially lower impact from tariffs. 

Latvian economy, overall, continues to stagnate, however positive signs are also visible in the data. While Latvian year-on-year GDP growth has been negative for the last 3 quarters in a row, decline in GDP in 2025 Q1 was the smallest in these 3 quarters, as in 2024 Q4 and 2024 Q3 GDP declined by 0.4% and 0.9% respectively. Latvian domestic demand showed signs of improvement at the start of Q2, with non-food retail sales in constant prices rising by 3.6% year-on-year. Most notable turnover growth was registered in retail sale of electrical household appliances in specialised stores (of 12.4 %), retail sale of cultural and recreation goods (12.0 %), and retail sale via mail order houses or via Internet (11.5 %). Therefore, we are seeing signs of a recovery in demand for rate-sensitive goods – a sign that lower rates are also filtering through the economy. Leading indicators are also painting a more positive picture for the Latvian economy: in May Latvian industrial confidence grew to the highest level in almost 3 years (34 months), construction sector optimism rose to the highest level in 3 years and 3 months, while consumer confidence stabilised and is no longer declining. The improvement in soft data (surveys) is also supported by hard data, as in April volume of production in Latvian manufacturing (in constant prices) reached the highest level since July 2023, supported by increasing production in food, wood, textile, machinery and equipment, as well as rubber and plastics sector. What is more, in April 2025 production of cement in Latvia was up by almost 16% compared to April 2024, which is a cautious indication of looming recovery in construction sector. 

All in all, as the global economy continues to navigate the tariffs and tariff uncertainty, Baltic region has enjoyed mixed economic performance in 2025. While Lithuania maintains its position as the leader in terms of the economic cycle, its high dependence on export and manufacturing makes it potentially more vulnerable to tariff impact. While Latvian GDP continued to decline in Q1, soft and hard data indicate that economic cycle is gradually improving. In Estonia, the signals are mixed. While the cyclical elements of the economy improved somewhat, leading indicators suggest that economic cycle is weakening again, with part of weakness might be driven by tariffs, and part of the weakness may be stemming from a higher VAT rate which is set to kick in on July 1st.