European Road Ahead Special Report: Sizing Up Tariff Risks

In a new Macro-to-Micro report, a team led by equity strategist Beata Manthey observes that while Trump’s return to the White House adds a host of policy-related risks, tariffs are undoubtedly front and center. This raises a key question: How will tariffs impact the European economy and corporate earnings? 

On the economics front, economist Christian Schulz thinks a broad 10% tariff from the U.S. would reduce EU GDP by around 0.3 percentage point (pp) over two years. But there are a number of complicating factors to consider, including product-specific exemptions, additional actions on China, and retaliatory tariffs. 

Moving to equities, we estimate that a broad 10% tariff would likely shave some 1% to 2% from European earnings per share, an estimate based on our calculation of “tariffable” revenues. 

As for the investment implications, recent weeks have seen investors broadly punish both European stocks and U.S./Trump-exposed sectors within the European market. But there’s been little differentiation between U.S.-exposed firms despite what appears to be high variability in tariff risks. In our view, these trading dynamics reflect how complex it is to assess the exposure and resilience of individual businesses to Trump-related risks.

Our base case for the euro area 

Trump’s re-election will likely lead to policy changes, especially in U.S. trade, energy, security and fiscal policy. These changes will have important implications for the euro area’s economy and prices. Overall, we expect mixed growth implications (but likely negative on balance) and a disinflationary impact across these policy areas. In addition, regulatory policy may have important sectoral implications in Europe. 

At the moment important details of U.S. trade policy in 2025 aren’t known. But our base case reflects several assumptions.

• We expect a 10% U.S. tariff on most trade partners, including the EU, beginning in the first half of 2025. Simulations suggest this would reduce EU GDP by around 0.3 pp over two years. But the 10% may not be applied to all products and trade partners; there are suggestions that it will also depend on trade partners’ reciprocal tariffs. There’s a good chance that U.S. tariffs on the EU could be smaller than 10%, with smaller economic damage. It’s also possible that the U.S. tariff announcement will be the opening of negotiations, with the EU making offers to stave off the threat. The impact may also be diminished by tariff-free quotas and exemptions.

• We also expect action on China. During the campaign, Trump floated a 60% additional tariff on imports from China. While we don’t assume this would be fully implemented, we do assume significant action against China. Our rule of thumb is that a 1% GDP growth hit for China reduces German GDP by 0.2% and GDP for the rest of the EU by 0.1%. In addition, Chinese exports will likely be diverted from the U.S to the rest of the world, pushing down consumer prices but also reducing profits and employment for EU firms.

• We don’t expect the EU to retaliate like-for-like against U.S. tariffs. U.S. exports to the EU are much smaller, so to impose the same damage EU tariffs would have to be much higher. A quarter of EU imports from the U.S. are mineral fuels, which the EU is unlikely to want to make more expensive, and the same is true for pharmaceuticals. We expect retaliatory EU tariffs to be focused on maximizing political leverage, such as by targeting U.S. farmers or specific congressional districts, while minimizing the economic damage in Europe.

• We anticipate targeted “safeguards” from the EU against China. Looking back at Trump’s first presidency, the only tariff introduced by the EU against China was a “safeguard tariff” against Chinese steel linked to the U.S.’s introduction of trade restrictions on steel products. We could see such a response being used in a targeted way this time. Note that safeguard tariffs wouldn’t be inflationary compared to a baseline without U.S. trade actions, as they’d only impact new trade flows.

We see the reduced GDP growth for the euro area as an additional shock to the already-beleaguered manufacturing sector, which will likely weigh on employment and wages and could add to pressure on the European Central Bank to cut interest rates below neutral. 

We don’t expect EU retaliation to have much effect on EU growth or inflation; imports from the U.S. account for just more than 10% of euro-area goods imports, but 25% of this is energy, which is unlikely to be taxed.

Implications for the UK 

We expect a blanket 10% tariff scenario for the UK would mean a moderate shock to UK activity: 0.2% in the first year and 0.3% cumulatively overall. There would be a net disinflationary effect, with CPI around 0.35% below a baseline projection after 18 months or so. 

Our analysis suggests the 10% tariff shock would imply an initial gross hit to activity of around 0.7%, likely in the first instance to be a larger hit to demand. In reality, however, the net effect on growth is likely to be less, and accompanied by a net disinflationary effect. The impact on UK exports would likely be reduced by some modest diversions into continential Europe. The net outcome here will depend on the scale of any associated retaliation and/or political spillover; the substitutability between input from different sources; and the associated reaction of foreign exchange.