Why Trump's plans for tariffs could be bad for Europe's economy

Why Trump’s plans for tariffs could be bad for Europe’s economy

Posted by Admin November 4, 2024 Bussiness

Donald Trump’s victory may harm Europe’s economy as proposed 10% US tariffs risk hitting European exports such as cars and chemicals, eroding Europe’s GDP by up to 1.5% or about €260bn. Analysts warn of ECB rate cuts, euro weakness, and a recession risk.

Donald Trump is heading for the White House which could spell serious trouble for Europe’s economy.

According to several economic analyses, there is broad agreement that Trump’s proposed 10% universal tariff on all US imports may significantly disrupt European growth, intensify monetary policy divergence, and strain key trade-dependent sectors such as autos and chemicals.

The long-term effects on Europe’s economic resilience could prove even more significant if tariffs lead to protracted trade conflicts, prompting the European Central Bank (ECB) to respond with aggressive rate cuts to cushion the impact.

Trump’s tariffs could severely hit trade-dependent European economies

Trump’s proposed across-the-board tariff on imports, including those from Europe, could profoundly impact sectors such as cars and chemicals, which rely heavily on US exports.

Data from the European Commission shows that the European Union exported €502.3bn in goods to the US in 2023, making up a fifth of all non-European Union exports.

European exports to the US are led by machinery and vehicles (€207.6bn), chemicals (€137.4bn), and other manufactured goods (€103.7bn), which together comprise nearly 90% of the bloc’s transatlantic exports.

ABN Amro analysts, including head of macro research Bill Diviney, warn that tariffs “would cause a collapse in exports to the US,” with trade-oriented economies such as Germany and the Netherlands likely to be hardest hit.

According to the Dutch bank, Trump’s tariffs would shave approximately 1.5 percentage points off European growth, translating to a potential €260bn economic loss based on Europe’s estimated 2024 GDP of €17.4tn.

Should Europe’s growth falter under Trump’s tariffs, the European Central Bank (ECB) may be compelled to respond aggressively, slashing rates to near zero by 2025.

In contrast, the US Federal Reserve may continue raising rates, leading to “one of the biggest and most sustained monetary policy divergences” between the ECB and the Fed since the euro’s inception in 1999.

The likely outcome: a weaker euro, which could help offset some competitive disadvantages for European exporters but would also increase import costs.

Dirk Schumacher, head of European macro research at Natixis Corporate & Investment Banking Germany, suggests that a 10% tariff increase could reduce GDP by approximately 0.5% in Germany, 0.3% in France, 0.4% in Italy, and 0.2% in Spain.

Schumacher warns that “the euro area could slide into recession in response to higher tariffs”.

European corporate earnings and investment at risk

According to Goldman Sachs’ economists James Moberly and Sven Jari Stehn, the broad tariff would likely erode eurozone GDP by approximately 1%.

“European economies are more exposed to trade and, importantly, more sensitive to trade policy uncertainty,” the expert stated. Economists added that, if Trump is re-elected, leading to higher tariffs and weaker European growth, the ECB may respond with faster rate cuts in 2025.

For individual European businesses, the outlook is equally concerning. Goldman Sachs analysts project that a 1% GDP loss translates into a hit to earnings per share (EPS) for European firms by 6-7 percentage points, which would be sufficient to erase expected EPS growth for 2025.

Given the lingering effects of trade policy uncertainty, European firms may also respond by curtailing capital expenditures, as they did during the previous trade tensions.

Between 2018 and 2019, firms with high exposure to US tariffs cut investment by as much as 2 percentage points, a trend that is likely to recur under Trump’s proposed tariffs.

The chemicals and automotive sectors are particularly exposed; German automakers, in particular, could face severe difficulties in the US market if tariffs reach the proposed 10% level.

A recent UBS report by economist Samuel Adams and colleagues estimates that under a universal 10% US tariff on all imports, the cumulative impact on euro area GDP would range between 0.5% and 1%.

The Swiss bank warns of negative implications for European stock markets, stating, “With almost 25% of STOXX 600 sales coming from the US, Europe would also be vulnerable. Consumer and technology sectors would be among the most vulnerable sectors in our view.”

Trump would cause an increase in European military spending

Goldman Sachs also warned that Trump’s foreign policies would force European economies to increase military spending.

Trump has indicated that he would cease US military aid to Ukraine, placing the responsibility on Europe to bridge the gap.

With the US currently allocating €40bn annually (or approximately 0.25% of EU GDP) to Ukraine’s support, European governments would likely be compelled to increase their own defence budgets.

Meeting NATO’s 2% GDP spending target, alongside compensating for reduced US support, could add 0.5% of GDP annually to the EU’s fiscal burden.

However, Goldman Sachs economists caution that higher defence expenditure would provide only a modest economic boost given Europe’s lower defense spending multipliers.

Moreover, it will cause “upward pressure on long-term yields from higher deficits and negative confidence effects from elevated geopolitical risk”.

Trump tariffs: Are fears likely exaggerated?

Some analysts suggest the impact could be far smaller than many expect.

A recent report from the London School of Economics, led by Aurélien Saussay, estimates a more modest 0.11% reduction in eurozone GDP, with Germany seeing a slightly steeper decline of 0.23% due to its reliance on automotive exports.

Italy, meanwhile, could experience a minimal effect, with its GDP forecasted to dip by just 0.01% under a universal tariff scenario.

Likewise, Andrew Kenningham, Chief Europe Economist at Capital Economics, anticipates a GDP reduction of less than 0.5% across the eurozone.

“A Trump victory in the US election would accelerate the structural shifts that are a major challenge for Europe including rising protectionism, reduced export opportunities to China and the US, and the need to spend more on defence at a time when fiscal positions are strained,” Kenningham wrote.

However, the expert warned that the damage would be far worse if this triggered a transatlantic or EU-China trade war.