1. Tariffs Likely to Weigh on Growth, Not Inflation
- US tariffs, particularly on steel, aluminium, and possibly broad 10–20% tariffs on other products, are expected to reduce European economic growth rather than trigger significant inflation.
- Estimated impact: 10% US tariffs could reduce euro area GDP by 0.2–0.3 percentage points and UK GDP by 0.1–0.2 percentage points.
2. Trump’s Tariff Strategy
- Aims to reduce US trade deficits, reshore production, and raise revenue to fund lower domestic taxes.
- Tariffs may be customized by country to offset non-tariff barriers like subsidies and VATs.
- EU faces tariffs already on steel and aluminium; further broad tariffs on European goods are possible.
3. Tariffs as a Political and Bargaining Tool
- Trump may use tariffs to pressure Europe to increase defense spending to NATO targets (2–5% of GDP).
- Tariffs could also be leveraged in post-Ukraine reconstruction deals to favor US firms.
4. Europe’s Trade Exposure and Response
- EU is the largest supplier of goods imports to the US, leading to Trump’s focus on the bloc.
- European reaction is expected to be “proportionate,” with possible tariff cuts on US cars as a gesture, though retaliatory tariffs on steel/aluminium remain a risk.
- The UK may be less exposed and might avoid some tariffs.
5. Channels Through Which Tariffs Affect Europe
- Higher tariffs raise costs for US consumers, reducing demand for European exports.
- European firms may cut prices to remain competitive, squeezing margins and weakening investment/consumption domestically.
- Currency effects: weaker EUR/GBP vs. USD could help growth somewhat.
- Longer-term: less trade openness may slow productivity growth.
6. Limited Inflationary Impact in Europe
- Inflation rise likely limited to 0.1–0.2 percentage points due to diminished pricing power of European manufacturers.
- Tariffs may increase spare capacity, offsetting inflation pressures.
- Inflation concerns dominate in the US, but in Europe, growth impact will be more significant.
7. Monetary Policy Outlook
- The Fed will focus on inflationary pressures and likely maintain a tighter policy.
- European central banks (ECB and BoE) are expected to cut rates further (up to four times each) to counteract tariff-related growth weakness.
- ECB terminal rate forecast: 1.75% by September 2025.
- BoE terminal rate forecast: 3.50% by February 2026.
