Higher For Longer With Tariffs, Port Fees, And German Spending

By Maartie Wijffelaars, senior eurozone economist at Rabobank

As expected, the BOE left its policy rate unchanged at 4.5% yesterday. The guidance was left untouched as it continues to pursue a “gradual and careful” approach, taking a meeting-by-meeting approach. In May, the MPC will take a closer look at the balance of risks: to what extent is policy uncertainty weighing on demand, and is there risk of fresh inflation persistence due to the current rise in the headline rate. This will inform their decision. Our BoE watcher Stefan Koopman still forecasts a 25bp cut every quarter, focusing on the meetings with forecasts and a press conference. For more details please read his post-meeting comment.

In a hearing of the Committee on Economic and Monetary Affairs of the European Parliament, yesterday, Lagarde also reiterated that the ECB will follow a meeting-by-meeting approach. Uncertainty over the trade policy environment makes it impossible to commit to a predetermined path. Nothing new here. She was more specific, however, about the possible impact of tariff hikes on GDP growth and inflation than before. She underscored the high uncertainty about how specific trade measures would look like, and about their impact on the inflation outlook. But she mentioned that ECB analysis tells that a 25% US import tariff on EU goods would lower Eurozone GDP growth by 0.3% in the first year. If the EU raises tariffs in response this would raise the impact to 0.5%. It could also lift inflation by about 0.5% in the short term, with the impact easing in the medium term, as lower economic activity would stem the inflationary impact. In a way, the view matches Powell’s base case that the inflationary impact would be transitory.

In a recent scenario analysis we also calculated that a 25% US import tariff hike on EU goods and partial retaliation by the EU, would lower Eurozone GDP growth by about 0.5% in two years. Although the negative impact would grow a few percentage points larger in the years thereafter. The risk, in our view, is to the downside, with the main wild card being the extent to which uncertainty would hurt investment decisions. The impact on inflation was much higher in our modelling exercise, at between 1.5 and 2 percentage points in two years. The inflationary impact clearly depends on the extent to which the EU would decide to react. In this scenario the average tariff hike in the EU on US goods was somewhat less than 10%.

The EU remains in favor to negotiate a deal, but it has said to take countermeasures if the US proceeds with unjustified tariffs. At the same time, it is mindful of the negative economic impact of higher import tariffs on its own economy and will continue to respect international trade rules. Altogether this likely implies that it would retaliate US tariffs with a relatively smaller package of rebalancing tariffs at first, threatening to do more if the US doesn’t halt the tariffs. Beyond increasing tariffs on US goods it has a broad range of other rebalancing measures at its disposable. It could for example implement or increase quotas and restrict trade through export bans, restrict access to EU public procurement rounds and in some cases foreign direct investment. In a nuclear option it could even suspend international property right obligations.

In a hearing at the European Parliament yesterday, EU trade commissioner Maros Sefcovic said that the EU will delay the first part of its rebalancing package to the recent US steel and aluminium tariffs. The tariff hikes on Harley Davidsons and US bourbon were supposed to come into force on 1 April, but are now reviewed and delayed to mid-April, when the second and final part of the rebalancing package is planned to come into force. According to Sefcovic this provides time to “consult with member states on both lists simultaneously, and also give extra time for negotiations with our American partners.” He is “convinced that continued engagement and a positive approach is the best way forward.” Some might say that the move has something to do with the fact that governments of France, Italy and Ireland were scared by the threat of Trump to impose a 200% tariff on EU spirits, retaliating the EU’s hike on US bourbon.

But the delay surely didn’t mean cancellation, the Commission said. Moreover, Sefcovic also stated that the EC will prepare a “calibrated” response to any announcement that is expected on the 2nd of April. This arguably could involve a big as well as close to no response. Recall that on 2 April a report on trade relationships and security issues is due. Additional sectoral tariffs may follow immediately after that report, as well as broader “reciprocal tariffs.” This announcement may well change the entire game, again.

Next to goods tariffs, possible upcoming US port fees on China-linked shipping of up to USD 1.5 million, and obligations to use US flagged, operated and built ships for a certain share of US exports, also have the potential to create inflationary pressures and disrupt global supply chains. The consultation period on a draft executive order including these proposals will close next Monday, when a public discussion will be held at the International Trade Commission. The draft also includes that allies should work with the US and implement similar measures or risk retaliation.

The plan could impose significant costs for ocean carriers, raising delivery costs of US coal by up to 35%, for example, according to Xcoal Energy & Resources CEO Ernie Thrasher. And it could also significantly limit US LNG exports, as there are currently no “US built, US flagged LNG carriers in operation nor on order”, according to BIMCO. Reuters reports that the plan is already “choking US coal and agricultural exports”, and rather than facing up to a 35% increase in costs, some carriers may cease carrying US exports entirely. Smaller carriers are seeing a drop-off in activity until the new maritime cost structure is clear. For more historical context, and insightful details and implications of the draft please read the piece of our global strategist Michael Every, In Deepest Ship.