US tariff hikes expected to depress US growth, EU report finds

A new analysis by the European Commission concludes that the latest round of US tariff increases is likely to weaken, rather than strengthen, the US economy. The study models a 15-percentage-point rise in the effective US tariff rate and finds that the measures act as a classic cost-push shock. Higher duties make imported inputs more expensive, raise consumer prices and ultimately weigh on real wages and corporate margins.

The report shows that any short-term boost to domestic producers from reduced import competition is quickly outweighed by inflationary pressures and a decline in households’ purchasing power. A stronger US dollar, prompted by the tariff shock, further erodes the competitiveness of American exporters. As a result, US GDP falls despite the additional government revenue collected on imports.

The Commission also challenges the assumption that tariffs improve the trade balance. While imports initially decline, exports fall as well once the dollar appreciates, leaving only a temporary narrowing of the deficit.

For Europe, the model points to moderate but noticeable GDP losses. EU exporters face weaker demand from the US, though some of this is offset by market-share gains in third countries as American producers lose competitiveness. The EU nevertheless suffers a terms-of-trade loss, which reduces the purchasing power of European incomes beyond the fall in output.

A scenario in which the US applies tariffs broadly to other trading partners produces a sharper short-term shock for the EU, though the effect stabilises as European exporters maintain access to the US market. Retaliatory tariffs by Europe, however, would deepen the downturn on both sides. In such a case, the United States would lose the small terms-of-trade gain it achieves in the baseline scenario, shifting the full cost of the measures back onto domestic firms and consumers.

Financial markets play a crucial role in the outlook. The Commission notes that US markets already reacted to the April tariff announcements with signs of heightened uncertainty and a rise in the US risk premium. When this is incorporated into the model, the negative impact on US investment and consumption becomes more pronounced.

Additional sensitivity tests show that if tariffs are perceived as permanent, the US captures a larger share of the income gain from trading partners, but the overall effect on domestic output remains negative. Under dominant-currency pricing, the global impact is harsher, as exchange rate adjustments contribute less to the rebalancing of trade flows. A looser Federal Reserve stance could mitigate part of the downturn but only at the cost of higher inflation.

Source: European Commission, Photo: Fotolia