Tariff war dampens outlook and raises risk

Donald Trump's tariff announcement on "Liberation Day" 2 April has been the dominant theme in economics and financial markets for the last month. It was well-known that tariffs were coming, but the level was a surprise. Import tariffs were set for each trading partner at between 10 and 50 percent, increasing the average US tariff (together with some other changes) from 2.5 to approximately 22.5 percent. Later, tariff increases above 10% have been postponed for 90 days and some exemptions been introduced, but tariffs on most Chinese imports have been raised sharply to 145 percent. In theory, that increases the average import tariff by even more than the 90 days postponement lowered it.

As they currently stand, the tariffs represent the largest tax increase in the US since the second world war, and they will likely have a significant negative effect on demand as they erode consumer spending power and corporate profits. That effect might be mitigated by other tax cuts in 2026, but we expect to see a negative effect on US GDP growth of 0.5-0.75 percentage points this year as a direct consequence. In addition, there will likely be some short-term supply disruptions and a negative effect on consumer and business sentiment and hence willingness to spend. The data for April so far suggest that the economy is holding up relatively well, with job growth of 177,000 and manufacturing PMI of 50.7, which indicates increasing production at a slightly higher pace than in March, although with weakening export orders. However, even if policies were to remain unchanged, the economic consequences are hard to predict, as we have no recent experience with tariff hikes of this magnitude.

Outside the US, China will likely see a significant impact on its economy from lower exports, even if there is significant re-routing of exports to the US through other countries. However, China is accelerating its efforts to increase domestic consumption which can to some extent dampen the impact, and we expect the net result to be about 1 percentage point lower GDP growth.

Growth in the euro area is also likely to be negatively impacted by lower US demand. We estimate the effect to be around 0.25 percentage points lower growth. In addition, there could be a negative sentiment effect, but April data does not suggest it is large. Also in the euro area, manufacturing actually surprised to the upside in April, with PMI hitting 49.0, the highest level since August 2022, while services disappointed. The US tariff hikes could lead to price increases in Europe if they trigger European counter-tariffs or disruptions in global supply changes. However, the ECB signalled in April (and we agree) that the primary risk for inflation is to the downside because of the risk to economic growth and as global good prices can come under pressure as is already evident in the oil price. A significant appreciation of the EUR and further signs of slowing wage growth point in the same direction. The ECB cut its deposit rate by 25bp to 2.25% at its April meeting and in our view, the balance of risks speaks for further cuts, even though core inflation surprised to the upside in April by increasing from 2.4% to 2.7%y/y, possibly influenced by the timing of Easter.

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