How Tariff Troubles May Hurt Europe’s Growth

Markets rallied on the announcement of President Trump’s 90-day pause in his administration’s new global trade tariffs—with notable exceptions:

• The moratorium was restricted to trade partners that haven’t retaliated.
• Reciprocal tariffs weren’t lifted but instead lowered to 10%, except for China, which is now subject to a 125% levy.
• The 25% global tariff on steel, aluminum and automobile imports remains in force.

As well as the actual impact of the tariff measures, business confidence has also taken a hit, with survey evidence already pointing to lower economic growth. Further tariff-related initiatives, such as the US inquiry into imports of pharmaceutical goods and semiconductors, will likely create more uncertainty and loss of confidence.

Tariffs Are Already Damaging Europe’s Growth

Instead of the previously announced 20% tariff, the European Union (EU) is now subject to a 10% universal tariff—still a higher effective tariff rate than prior to the April 2 US announcement. Meanwhile, the EU voted on April 9 to impose tariffs on €21 billion of US goods—countermeasures that have also been put on hold. Despite the tariff pauses, the danger for euro-area economies is far from over, and damage is already being done.

Based on our assessment, growth is set to fall, with risks skewed to the downside. Compared with a counterfactual scenario in which the new tariffs were never implemented, and with only marginal damage to confidence, the hit to growth will probably be substantial. In the Display below, we show our 2025 forecasts across different scenarios. The wide range of possible outcomes reflects the high level of tariff uncertainty.

 

With economic recovery still only recent and weak, the euro area is once again likely to face low growth or recession risks, partly from tariff impacts and partly from uncertainty and loss of confidence.

Risks of Inflation Undershoot Are Rising

The eurozone was already heading towards its target 2% inflation on a sustainable basis during the course of this year. However, with growth now expected to weaken and the economy potentially to enter recession, the downward pressure on inflation is likely to intensify, aided by three additional factors:

• Energy prices are a major driver of inflation: they fell significantly following the April 2 US tariff announcement and remain relatively depressed.
• Financial conditions in the US have been tightening, and the euro area could experience the initial knock-on effects. Meanwhile, the euro has strengthened against the US dollar, making US imports cheaper. If the euro remains strong, this effect will continue.
• China will continue to seek markets for its exports because tariff barriers make exporting to the US uneconomic. The country will likely reroute its goods to other regions, notably the EU. This was the case during Trump’s first round of tariffs, when exports to the EU surged (Display, below). The reaction is likely to be greater this time around.

 

 

Hence, our baseline forecast is that the European Central Bank will cut policy rates to below 2%, reaching 1.75% by the end of December. The probability of more cuts increases in line with recession and undershooting risks.

No Easy Solutions from Fiscal Policy

Fiscal policy is unlikely to be as supportive as it was during the energy crisis, as most EU member states face tight budget constraints.

Some countries might provide sector-specific relief, like the €14 billion package the Spanish government announced recently. But only Germany has the headroom to provide material fiscal support. Given that Germany could be facing a third year of recession, it’s possible that fiscal restrictions will be suspended to provide immediate support to its industries.

Even so, the EU as a whole faces a tough position.