EU should avoid retaliating to US tariffs and focus on new trade partners

Brussels – No trade war. Although the European Commission wants to respond to US tariffs and not allow US President Donald Trump to act freely and with impunity, a suggestion from the European Parliament points precisely in the opposite direction. The institution’s think tank clarifies that “Europe should avoid reactionary protectionism, as broad retaliatory tariffs would exacerbate economic strain rather than alleviate it.” With intransigent conduct, a study warns that the EU and, even more so, its euro area would have much to lose.

European inflation rises with EU counter-tariffs

First, analysts want to clarify a key issue related to inflation. US tariffs “do not directly affect prices for European consumers.” The opposite is true, namely that tariffs imposed by Washington affect US consumers’ prices for goods imported from Europe. European companies will see reduced demand from US importers because of this and, “conceivably,” will respond by trying to regain demand by lowering prices for both US and European consumers. This is the deflationary effect of a foreign tariff.

US tariffs could raise concerns about euro area inflation because of two indirect effects: the euro’s depreciation and retaliatory tariffs imposed by the EU on US imports. That is why the European Commission, responsible for trade matters, should refrain from the urge to go into a confrontation. Also, while European exports to the United States may suffer declines due to higher tariffs, the euro’s depreciation may partially offset these effects by improving competitiveness in global markets.

ECB should avoid raising interest rates

The European Parliamentary Study and Research Center analysis then contains a helpful suggestion for eurozone resilience concerning the European Central Bank. Against this backdrop of uncertainty, it points out, “monetary policy flexibility remains a crucial tool in mitigating the contractionary pressures of US tariffs,” urging to beware of a“miscalibrated” response. In particular, it explains, “an overly restrictive stance by the ECB could amplify the economic slowdown rather than counteract it.”

Increasing interest rates and thus higher borrowing costs would risk strangling the economy, a fear the ECB expressed as early as August 2023, as did members of the previous community executive. What comes from the European Parliament is just a new call for caution.

EU can make it, trade diversification is a good strategy

Therefore, a significant part of the possible negative fallout from US protectionism comes from European responses. “Overall, while the US shift towards protectionism introduces new economic risks, its impact on the European economy remains manageable if appropriate policy responses are adopted,” according to the study.

In this sense, the study points out that a strategy focused on trade diversification, innovation incentives, and monetary flexibility would better position Europe to absorb the negative spillovers of US trade policies. Thus, the decision by EU Commission president Ursula von der Leyen to give new impetus to trade and conclude free trade agreements with Mercosur countries first (Argentina, Bolivia, Brazil, Paraguay, Uruguay) and then with Mexico seems appropriate. Just as the choices of wanting to reach a trade agreement with India by the end of the year and give new impetus to cooperation with South Africa seem appropriate.

The real problem with US tariffs is China

On closer inspection, the EU and its eurozone’s main risk from US tariffs is ‘made in China.’ What poses “a serious challenge” is the possibility of a so-called ‘second China shock,’ in which Chinese exports, redirected by the United States because of tariffs, inundate European markets. The EU will have to know how to find a balance to fend off a new and much more intense competition “influencing major European industries.”

English version by the Translation Service of Withub