On April 2, former President Donald Trump made headlines by announcing sweeping new tariffs, which many initially feared would exacerbate inflation in Europe. In a surprising turn of events, economists and policymakers are beginning to predict that these tariffs may actually have a cooling effect on inflation across the euro area. This change of heart happens just as many experts are combing through the data of yesterday to make sense of today’s real estate market.
The announcement of the tariffs was followed by a burst of inflation expectations, especially on the part of firms and consumers. New analyses indicate that the real effect is much different than first impressions. Past episodes suggest that around 15% of the excess supply due to the tariffs will likely flow into the euro area. Goods supply is up by 1.5% to 2%. To pay attention to this increase is to ask big questions about macroeconomic price stability in the area.
The Economic Landscape Shifts
Chief Economist Giovanni Pierdomenico has offered perspective on what could be the impact of Trump’s tariffs. He’s projecting that this new supply will cause a drop. More specifically, he forecasts core goods prices will decrease by 1.5%. This perspective is more consistent with the argument that the tariffs are inducing disinflationary rather than inflationary pressures.
“We estimate this should translate into around -1.5% of downside to the price level of core goods, corresponding to -0.5% downside to core HICP,” – Giovanni Pierdomenico.
In mid-June, European Central Bank (ECB) President Christine Lagarde was seconding that analysis. In her testimony, she focused on the broader economic impacts of these tariffs. She noted that the tariffs would have a likely disinflationary effect. If done right, this should encourage policymakers to reconsider risks of growth.
“Tariffs are probably more disinflationary than inflationary,” – Christine Lagarde.
So far, the ECB Governing Council has moved quickly to respond to rapidly shifting economic circumstances. They decided to reduce the deposit facility rate by 25 basis points, bringing it down to 2.25%. This move symbolizes the hardening of a new consensus among policymakers that growing downside growth risks warrant a more accommodative monetary policy stance.
Energy Prices and Global Demand
A second major factor driving this economic shift is the large decline in energy prices since early April. Since that announcement, oil prices have plummeted by more than 15%. At the same time, the European Dutch TTF natural gas benchmark has plunged by more than 22%. These unexpected declines have exacerbated the perception of deflation in Europe.
With the continued decrease in energy costs, the production expenses overall are bound to go down as well. This would offer an important antidote to the inflationary effects of tariffs. From an economic perspective, the interaction between the effect of energy prices and the effect of the tariff is key to understanding the overall economic impact to Europe.
Lagarde said that shifts in the nature of global supply chains could further help determine where prices go in Europe.
“China will have overcapacity, will want to reroute its exports somewhere, possibly to Europe. That would have a dampening impact on prices,” – Christine Lagarde.
Revisions to Economic Forecasts
Just last week the ECB cut its GDP projections for the euro area. These changes further emphasize the unpredictability of tariff roll outs and their impacts on detrimental economic development. The bank cut its GDP forecast for 2025, downgrading expectations there to 0.8%. For 2026, it fell to 1.0% because of worries over tariff-induced risks, a strong euro and overall weak global demand.
As we predicted, economists such as Alexandre Stott have warned that these three converging factors would cause contractions in some of Europe’s largest economies.
“We already forecast small contractions for Germany, Italy, and Switzerland in Q3 this year,” – Alexandre Stott.
Disinflationary forces and lower effective growth expectations will make further rate cuts indispensable, in our view. He thinks these reductions would be enough to lower a median rate to 1.5% by September.
“Disinflationary forces mean the ECB is likely to cut rates further to 1.5% by September,” – Bill Diviney.
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