Wednesday, December 4, 2024

Tariffs and Tensions: How Trump’s Policies May Impact the Euro Zone Economy

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Euro Zone Economy Seen Hit Early Next Year by Trump Tariffs, Say Economists

The euro zone economy is predicted to face new challenges early next year due to tariffs imposed by the incoming U.S. Trump administration, according to a recent poll of economists. These tariffs are anticipated to likely trigger a series of interest rate cuts from the European Central Bank (ECB).

President-elect Donald Trump’s proposed tariffs are expected to significantly affect the euro zone economy over the next two to three years. This consensus emerged from a strong majority of economists polled, who have also raised concerns about the risks of reflation in the U.S.

“Many questions are unresolved, but for now the signs point to weaker growth, more likely disinflation, and lower ECB policy rates,” said Greg Fuzesi, an expert on the euro area economy at J.P. Morgan. “The threatened tariffs would be much bigger this time around and could come at any time,” he noted.

In a survey conducted between November 8 and 14, nearly 85% of economists, or 37 out of 44, expected Trump’s proposed tariffs—a 10% universal levy on imports from all foreign countries and a 60% levy on Chinese imports—to be implemented early next year. A similar proportion, 34 out of 39, indicated that these tariffs would significantly impact the euro zone economy in the coming years.

Since Trump’s U.S. election victory last week, market pricing has swiftly shifted towards fewer U.S. Federal Reserve rate cuts and more ECB reductions. Some ECB officials have expressed concerns as well. Bundesbank President Joachim Nagel recently mentioned that the tariffs, if enforced, could cost Germany 1% in economic output, potentially leading its economy into negative growth.

Currently, markets are expecting around 150 basis points (bps) of ECB rate cuts between now and the end of 2025, compared to about 75 bps of Fed reductions, suggesting more pressure on the euro, which has already dropped nearly 4% against the dollar since the election.

Most economists in the survey predicted a total of at least 125 bps in ECB reductions by the end of 2025, slightly less steep than market pricing. Over 90% of economists, 69 out of 75, forecast that the ECB would lower its deposit rate by 25 bps for the third consecutive meeting in December. Nearly 70%, or 51, anticipate two more cuts in the next quarter, bringing it to 2.50%.

Despite many downgrades to their 2025 forecasts, poll medians still expect the euro zone economy to grow by 1.2% in 2025 and 1.4% in 2026, unchanged from last month’s figures. This projection does, however, suggest potential downside risks.

Henry Cook, a senior economist at MUFG, stated, “There are a wide range of sub-scenarios that include a global rise in tariffs between the U.S., EU, and China, and a sharp increase in uncertainty around global protectionism is certainly significant.” He estimates a 0.4 percentage point hit to euro zone growth next year.

Inflation, which was at the ECB’s 2.0% target last month, is expected to average 2.2% this quarter, returning to the target next quarter. It is forecasted to stay around this level through 2027.

Nearly 70% of economists, or 43 out of 63, anticipate the deposit rate to be 2.00% or lower by the end of next year. This is a larger majority compared to 60% who shared this view in October. Among 44 common contributors across two polls, 43%, or 19 economists, downgraded their end-2025 rate forecasts.

The ECB does not have an official estimate for the neutral rate—which neither curtails nor stimulates the economy—but a staff-published paper earlier this year suggested a real rate of around zero when adjusted for inflation, equating to about 2% in nominal terms.

“Instead of the ECB policy rate returning to neutral by mid-2025, we now see it falling moderately below neutral by end-2025,” said Mark Wall, chief Europe economist at Deutsche Bank. “This outlook partly relates to the prospect of U.S. tariffs under a new Trump administration and, partly, a weaker underlying macroeconomic performance and the emerging threat of below-target inflation.”

Alexandra Bennett
Alexandra Bennetthttps://www.businessorbital.com/
Alexandra Bennett is a seasoned business journalist with over a decade of experience covering the global economy, finance, and corporate strategies. With a Bachelor's degree in Economics and a Master's in Business Journalism from Columbia University, Alexandra has built a reputation for her insightful analysis and ability to break down complex economic trends into understandable narratives. Prior to joining our team, she worked for major financial publications in New York and London. Alexandra specializes in mergers and acquisitions, market trends, and economic

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