China’s economy expanded by a better-than-expected 5.4% in the first quarter, maintaining a strong momentum, even as U.S. tariff threats prompt major investment banks to slash the country’s annual growth outlook.

The first-quarter GDP topped Reuters’ poll expectations for a 5.1% growth year on year, building on a recovery that began in late 2024, thanks to a broad policy stimulus push.

Retail sales in March rose by 5.9% year on year, according to data from National Statistics Bureau on Wednesday, sharply beating analysts’ estimates for a 4.2% growth. Industrial output expanded by 7.7% from a year earlier, versus median estimates of 5.8%.

Fixed asset investment grew 4.2% in the first quarter against estimates of a 4.1% increase in a Reuters poll. However, the drag from real estate worsened within fixed asset investment, down by 9.9% for the year as of March, while infrastructure and manufacturing investment picked up pace.

The urban unemployment rate slipped to 5.2% in March, following a two-year high of 5.4% in February.

The statistics bureau described the Chinese economy as “off to a good and steady start” and emphasized how “innovation [was] playing an increasingly leading role.” Chinese startup DeepSeek in January revealed its AI breakthrough that rivals tech from U.S.-based OpenAI.

But the officials warned that “the external environment is becoming more complex and severe” and that domestic demand remained insufficient.

“We must implement more proactive and effective macro policies, expand and strengthen the domestic economy … and actively respond to the uncertainties of the external environment,” the bureau said in an English-language release.

The Chinese leadership has set an ambitious annual growth target of “around 5%” this year, a goal seen harder to achieve given the prospects of an escalating trade war and persistently lackluster domestic consumption.

The strong GDP growth shows that “the stimulus was very effective in boosting consumption and supporting investment,” said Tianchen Xu, senior economist at Economic Intelligence Unit, while cautioning that growth in China’s economy has typically been robust at the start of the year before tapering off.

“The trade war 2.0, where China and the U.S. are effectively imposing trade embargos on each other, will have a sizeable impact on China’s export sector and CAPEX (capital expenditures) will slow as a result,” Xu said.

The statistics bureau said the share of China’s exports to the U.S. had declined to 14.7% in 2024 from 19.2% in 2018.

Despite the upbeat monthly data in March, “damage from the trade war will show up in the macro data next month,” said Zhiwei Zhang, president and chief economist at Pinpoint Asset Management, noting that “high frequency indicators suggest exports [have] slowed sharply in the region.”

The tit-for-tat tariff war with the U.S. has brought total levies imposed by U.S. President Donald Trump on Chinese goods to 145%, drawing retaliation from Beijing to raise levies on U.S. goods to 125%. Such levels of import duties are expected to dent China’s exports and knock several percentage points off the economy’s expansion this year.

“Growth is likely to deteriorate rapidly from the second quarter given the low possibility of near-term bilateral negotiations to establish an offramp for the 125% tariff hike,” a team of economists at Morgan Stanley said in a note earlier this week.

Several investment banks have cut China’s growth forecasts this year, with most economists doubting Beijing would achieve its official target, citing headwinds from the substantial increase in U.S. tariffs on Chinese goods.

On Tuesday, UBS Group added to a series of growth downgrades with the most pessimistic forecast among major banks, projecting China’s economy to expand just 3.4% this year as U.S. tariffs choke exports. The investment bank projects China’s exports to the U.S. to fall by two-thirds in the coming quarters, with overall exports declining 10% in dollar terms this year.

There’s growing anticipation that Chinese officials will release more forceful stimulus measures to bolster domestic consumption and the housing market to counter the potential trade disruption.

“The urgency for more policy easing is on the rise and fiscal expansion will likely do most of the heavy lifting to stabilize growth, though this should be still insufficient to fully offset the severe external shocks,” Lisheng Wang, China economist at Goldman Sachs said in a note on Wednesday.

Morgan Stanley’s chief China economist, Robin Xing, expects Chinese authorities to frontload monetary easing steps in the second quarter, with a 50-basis-point cut in the reserve requirement ratio and a 15-basis-point cut in interest rates.

Beijing is likely to accelerate the issuance and deployment of local construction bonds and ramp up the consumer goods trade-in program with broader coverage or more generous subsidies, as well as a push for local governments to destock housing inventory, Xing said.

He also expects China to unveil an additional fiscal stimulus of 1 trillion yuan to 1.5 trillion yuan ($136.5 billion to $204.7 billion) in the second half of the year to provide a partial offset to the tariff shock.

Speaking at a media briefing following the data release, NBS Deputy Commissioner Sheng Laiyun warned that global protectionism was on the rise and China should “work harder” for its economic recovery.

China has decades of experience in responding to various crisis from the Covid-19 pandemic to U.S.-China tensions, Sheng said.

The U.S. tariffs will pressure trade but China’s economy would remain resilient, he added.