Eurozone - Tariff reversal is some relief, but no game changer

Liberation Day was supposed to provide clarity on future US tariff policy and by that a more certain eurozone economic impact. Liberation day, and one week later “Reversal Day” have – if anything – only lead to more policy uncertainty. This culminated in a 90-day pause for the reciprocal tariffs. The universal tariff of 10% stays in place, as do the separate 25% tariffs on steel & aluminium and cars & car parts. For the outlook, 3 points matter. 1) The pause is clearly a positive for growth, though it is not a game changer. European exports will still see a significant hit from the 10% baseline tariff as well as the 25% tariff on cars, steel & aluminium. If Trump follows through with a similar magnitude tariff on pharma, then the trade weighted tariff on EU exports to the US would rise to c15% from the c2-3% that prevailed until a month ago. 2) The euro has appreciated by c10% year to date, partly owing to general dollar weakness. Contrasting to earlier expectations it is therefore an additional drag on growth as it reduces export competitiveness (although good news for inflation – see below). 3) Tariffs and the US confidence shock have led to tighter financial conditions via weaker equity markets, albeit much less than that seen in the US. Against this backdrop, the eurozone economic recovery so far is unfolding broadly as expected. Frontloading is providing a small cushion, especially for the ailing manufacturing sector, and rising real incomes do provide a positive impulse to household consumption, but uncertainty is keeping a lid on investment and moving into Q2 tariffs will lead to a slowdown in growth. The latter was already showcased by the underwhelming April composite PMI. Further out, while tariffs negatively affect growth this year, fiscal expansion in the eurozone and especially in Germany has lifted the 2026 growth outlook.

Inflation in March edged lower with headline moving down to 2.2% from 2.3% in February, and core falling to 2.4% from 2.6%. Elevated services inflation has been the focal point of the ECB. Recently the outlook on that front is improving markedly. The most important driver is falling wage growth, with for instance the Indeed tracker moving another leg lower to a new post-pandemic low of 2.7% in Q1. The volatility in the wake of liberation day has also led to a strengthening of disinflationary forces. The euro has appreciated materially in recent weeks, and tighter financial conditions have added to growth headwinds. Oil and other commodity prices have fallen sharply. The result of the above is that our conviction in inflation leading to an undershoot of the ECB’s 2% target by the turn of the year has increased. While we now assume a more meaningful retaliation by the EU to US tariffs in our inflation forecasts, the impact of this merely offsets by the stronger euro and sharper fall in commodity prices. The US share of eurozone goods imports stands at just 13%; around 20-30% of goods consumption is imported; and goods makes up 26% of the HICP basket. Based on this, a 20% rise in the price of US goods imports adds only 0.2pp to HICP inflation.

At the April meeting, the ECB cut the deposit rate by 25bp to 2.25%, as widely expected. The tone in the press conference was dovish, reflecting the tariff hit to the growth outlook. More importantly, the April cut revealed a more dovish reaction function to tariffs; before, some Governing Council members still favoured a pause. Given the growth and inflation outlook we expect 75bp in rate cuts, taking the deposit rate to 1.5% by September.