A wave of erratic tariff announcements from the United States has further battered already the already weak Eurozone economic indicators, with last week's sharp decline in the ZEW Economic Sentiment Index collapsing to the point where it is on a par with other major crises like the 2008 Great Financial Crisis or the coronavirus global pandemic, Oxford Economics said in an emailed note on April 17.

 

The tariffs induced slowdown in the US comes on top of an already anaemic performance which “underscores the damaging effect of persistent policy uncertainty on growth expectations,” says Oxford Economics, which in response has downgraded its forecast for Eurozone growth.

“The rollercoaster of announcements from the US government since 'liberation day' on April 2 is continuing to affect incoming soft data. After Sentix last week, this week the ZEW's expectations component collapsed on a magnitude consistent with some of the worst crises, surpassed only by the immediate shock of Russia's invasion of Ukraine. Next week, we think the PMIs and the Ifo are likely to reinforce this trend,” says Daniel Kral, Lead Economist at Oxford Economics. “Some of the leading indicators coming out of the US have been breaking record lows. The key question is whether the collapse in surveys will translate into much weaker economic activity or whether the initial shock captured by soft data significantly overstates the underlying weakness.”

Oxford Economics now projects the Eurozone’s GDP will be 0.3% smaller by the end of 2030 compared to last month’s forecast, but the think tanks says a lot will depend on if the trade war escalates, which could easily happen. Kral warned that continued uncertainty and potential July tariff escalations could prompt further downgrades.

The European Central Bank cut interest rates by 25 basis points last week to 2.25% in an effort to stave off a recession in the Eurozone. And Oxford Economics says the ECB will probably cut rates by a further 25bp in June. However, the future policy path remains uncertain. According to Kral, “The effects of tariffs and trade policy uncertainty on growth are unambiguously bad. Their impact on inflation is more ambiguous.”

Kral notes that while a stronger euro, declining commodity prices and weakening demand could weigh on inflation, potential supply chain disruptions and corporate margin buffers will probably continue to push inflation higher.

“We think the ECB will err on the side of caution, at least for now. After cutting to 2%, which is widely seen as the neutral rate, the ECB is likely to stay on hold,” Kral said.

Recent industrial output data offered scant reassurance. February’s headline increase was primarily due to surges in Ireland and Belgium, where large pharmaceutical sectors are responding to anticipated US tariffs with inventory stockpiling. Both countries have very large pharma sectors, with pharma products accounting for 65%-75% of total exports to the US (and in the case of Ireland, accounting for around 15% of GDP), according to Oxford Economics.

“Excluding these outliers, output in the Eurozone contracted,” Kral said. He warned that the negative effects of new US trade barriers will likely be felt before Germany’s planned fiscal stimulus after the so-called Schuldenbremse (debt break) restrictions on German government borrowing were lifted this month, clearing the way for hundreds of billions of euros of borrowing to give the German economy a much-needed boost.

Negotiations between the EU and the US face a tight 90-day deadline to prevent the imposition of significantly higher US tariffs. Yet, meaningful progress remains elusive. “It’s not clear what the US wants,” Kral said, citing EU negotiators’ frustrations. A Japanese delegation met with Trump’s team to negotiate tariff relief. “So, what do you want from us?” they asked. Reportedly, the US negotiators had no answer, so the Japanese simply left. Likewise, Trump called on Beijing to open negotiations, but so far Chinese President Xi Jinping has not replied and appears to be simply waiting the US out, cutting off essential basic goods and sophisticated rare earth metals (REMs) exports to the US in the meantime. Imports from China to the US plunged by 64% in the first quarter of this year, according to official trade statistics, an unheard of drop. Countries around the world are looking to diversify their trade away from the US as fast as they can.

Kral added that demands such as rewrites to the EU’s regulatory framework or a strategic pivot against China are unrealistic. The White House is demanding countries uncouple their trade with China if they want more beneficial trade relations with the US, but few countries are willing to give up that trade for trade terms with the US that are worse than before the tariff regime was announced. Ultimately, “US trade policy may be decided by the bond market rather than anything the EU can offer” Kral adds, after international bond investors have fled the US treasuries market and bought into things like German Bunds which are now seen as a safe haven.