Economic overview 06/2025

GLOBAL OVERVIEW

US economy withstands tariff headwinds so far

While the latest US activity data do not yet fully reflect the economic damage caused by import tariffs and the accompanying uncertainty, business and consumer sentiment has deteriorated, consumer inflation expectations have jumped sharply, and a surge in goods imports ahead of April’s tariff announcement weighed on first-quarter GDP growth. This prompted analysts and economists to swiftly revise US economic growth forecasts downward – from over 2.0% to 1.4-1.5% for both this and next year.

The 0.2% decline in US GDP in the first quarter was largely the result of a sharp increase in imports, as businesses rushed to bring in goods ahead of the anticipated tariffs. This drop appears to be technical in nature and is expected to reverse in the coming quarters. Household spending — the key engine of US growth — continued to rise, albeit at a slower pace than in previous quarters. The US administration softened its stance on trade, reducing some tariff rates (from 145% to 30% on Chinese goods, and to 10% for others), which helped stabilize both US producer and consumer sentiment. Since mid-May, the downward trend in US GDP forecasts has also leveled off, nevertheless economic uncertainty remains elevated both domestically and globally.

Although many US import tariffs have been suspended for several months, reduced, or ruled illegal, the overall effective US import tariff level remains elevated — above 10%, compared to just 2.5% at the end of 2024. The future of several key tariffs is still uncertain. Both businesses and consumers alike are bracing for the possibility of higher tariffs and prices of goods in the future. There is a growing risk that the US economic cycle could weaken as the negative effects of tariffs start to weigh on consumption, business investment and manufacturing activity.

Euro area economy gains momentum at the start of the year

The euro area economy accelerated in the first quarter of 2025, with real GDP rising by 0.3% compared to the end of 2024. Both Germany and France avoided a technical recession — defined as two consecutive quarters of negative growth — and returned to growth after contracting in the final quarter of last year. Nearly all euro area countries posted growth in Q1, with the exception of Estonia, Latvia, and a few others. Still, the overall economic environment in the euro area remained fragile, as reflected in the fact that the volume of the German economy was unchanged from a year earlier.

Although economic activity in the euro area improved in the first quarter, much of the acceleration was driven by technical factors, and the region has yet to return to strong, sustained growth. The first-quarter improvement was largely supported by a rebound in manufacturing and large shipments to the US in anticipation of higher tariffs. In spring 2025, an interesting divergence emerged in the dynamics of sentiment indicators in the euro area: despite the looming tariffs, sentiment in the euro area manufacturing sector improved steadily since the end of 2024, while sentiment among service providers and consumers deteriorated in the spring. Consumers seemed most affected by tariff uncertainty, whereas manufacturers benefited from the restart of the US inventory cycle. On a positive note, early signs of stabilization in consumer sentiment emerged in May, as worries about tariffs’ impact on the economy and labor market began to ease. Together with lower borrowing costs, this could help support stronger domestic demand growth in the euro area moving forward. 

Euro area economic growth forecasts have remained relatively stable despite recent developments. GDP growth this year is expected to be close to last year's result, at around 0.8%, before accelerating above 1% next year. Increased defense spending and investment plans in Germany are projected to partially offset the negative impact of tariffs. However, given the openness of the euro area’s economy, it may be difficult for the euro area to ignore uncertainty in external markets.

US tariff policy about to lead to diverging inflation trends in the US and Europe

US tariffs are likely to drive up prices for goods in the US. In Europe, tariffs could ease inflationary pressures if Chinese and other exporters shift their focus to markets outside the US So far, the tariff-related uncertainty has indirectly contributed to lower inflation in both regions, due to declining oil prices. Additionally, in the euro area, the appreciation of the euro against the dollar by an average of 10% since the beginning of the year also helped to ease inflationary pressures. This currency shift reflects, among other factors, investors’ changing views on the dollar’s role as a “safe haven” amid ongoing market turbulence. Annual inflation in the euro area fell to 1.9% in May. 

Slowing inflation and fragile growth in the euro area have given the ECB room to ease interest rates further. Since the beginning of the year, the ECB has cut the deposit rate by an additional 1 percentage point to 2.0%. According to futures prices in financial markets, the deposit rate is expected to reach its lowest level in the second half of the year at 1.75%. This suggests that Euribor rates may soon also stop declining and may stabilize close to that level. However, much will depend on the direction of US tariff policy and its impact on the euro area economy — an outcome that remains uncertain, as US-EU tariff negotiations are still ongoing.

Unlike the ECB, the US Federal Reserve has paused its easing cycle, keeping the dollar interest rate steady at 4.25-4.50% since December. Despite the inflationary nature of US tariff policy, given the risks to the economy, market participants expect up to two US rate cuts in the second half of the year. Financial market forecasts suggest that US rates could stabilize in the 3.25-3.50% range over the next year.

BALTIC OVERVIEW

Latvian economy shows early signs of recovery

The Latvian economy continued to stagnate, albeit the first positive signs started to emerge in the data. Following contractions in the previous four quarters, GDP held steady on a quarterly basis for the second straight quarter, while on an annual basis, the contraction in Latvia's GDP in Q1 was the smallest in three quarters (-0.3%). Domestic demand showed signs of recovery at the beginning of Q2 after a contraction in the first quarter, with retail sales of non-food goods rising by 3.6% y-o-y in real terms. This suggests that lower rates are gradually starting to have a positive impact on the economy. Other indicators pointed to a more positive outlook. In May, Latvia's industrial confidence rose to its highest level in nearly 3 years, construction sector optimism – to its highest level in more than 3 years, while consumer sentiment also stabilized. The improvement in sentiment was also confirmed by activity data. In April, Latvia's manufacturing output (in constant prices) reached its highest level since July 2023, boosted by growth in food, wood, textiles, machinery and equipment, and chemicals. In addition, cement production in Latvia increased by almost 16% in April compared to last year, signaling a potential recovery in the construction sector.

Lithuania maintains its lead in the Baltic region

Lithuania’s GDP growth by 3% year-on-year was 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 as the leader in 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 stood at 10% and 12% of GDP respectively, which means potentially lower impact from tariffs. 

Cyclical sectors supported the Estonian economy in the first quarter

Estonia's economic performance has been mixed recently, with positive signals alternating with negative ones. While GDP declined by 0.3% year-on-year, there was some positivity in the data, as cyclical sectors like ICT, real estate, manufacturing had a positive contribution to GDP number, suggesting that business cycle has clearly improved. However, the sentiment indicators in Estonia worsened in April and May, potentially indicating risks to growth. Estonian industrial sentiment failed to improve further, with manufacturers becoming more pessimistic about export orders, production volumes 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 over the last year. However, we believe that the improvement in sales was partly technical and was likely driven by consumers bringing forward purchases ahead of the VAT hike to 24%, which will eventually increase the prices of goods and services.

All in all, as the global economy continued to navigate ongoing tariff uncertainty, Baltic region has enjoyed mixed economic performance in 2025. While Lithuania remained the regional growth leader, its high dependence on export and manufacturing makes it potentially more vulnerable to tariff impact. Latvian GDP continued to decline in Q1, but soft and hard data indicate that economic cycle is gradually improving. In Estonia, the signals are mixed. Although some cyclical sectors have shown modest improvement, leading indicators suggest the economic cycle is weakening again. This slowdown appears to be partly driven by tariffs and partly by the upcoming VAT increase scheduled for July 1st.