If a blanket 10% tariff is applied to US imports of European goods, we think the hit to Eurozone GDP could be between 0.3% and 1.0%. This is meaningful, even though this is below the forecasts of many international organisations, which overestimate the Eurozone’s loss of competitiveness.

In the more likely scenario of targeted and temporary trade spats between Europe and the US, the hit to Eurozone GDP may be between 0.1% and 0.4%.

The inflation impact is more ambiguous. A weaker euro and trade uncertainty would push up on inflation, while weaker activity would push down on it. The - 0.2% to +0.6% range we have for inflation includes both disinflation and inflation, but is skewed higher.

Countries such as Germany, Belgium, and the Netherlands would be worst hit, given their trade intensity and exposure to the US. 

However, some European countries may significantly increase their defence expenditure in response to Trump’s return to office, which could partially offset some of the negative drag from tariffs.

Indeed, German Chancellor Olaf Scholz’ decision to sack his finance minister – thereby dissolving his governing coalition – was partially motivated by considerations around looser fiscal policy. 

On balance, we think the ECB is likely to pursue somewhat more aggressive easing than it otherwise would have done. We now expect the ECB’s consecutive cutting cycle to extend to April.

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