Trade war: why the expected shock did not happen - July 28, 2025

A major episode in the trade war is coming to an end this summer. Despite alarmist predictions, the feared shock did not materialize as expected: why?

There are still a few unknowns, but it appears that tariffs on US imports will settle at around 16-20%, compared to 2.5% before the last US elections. A few adjustments are still possible — particularly upward adjustments on certain products such as medicines — but the brunt of the shock is behind us. The time has therefore come to take stock.

As expected, the sharp rise in US tariffs has had a measurable direct negative impact. Acting like a tax increase, it has slowed US household consumption, with growth falling to almost zero in the first half of the year (cf. chart 1). Construction spending has also slowed, and employment is slightly less dynamic. The maximum impact on prices is expected to be felt this summer and fall, with inflation at around 3.25%, before easing in 2026.

But beyond these inevitable direct negative effects, the surprises have mostly been positive. The much-feared overall negative impact, via uncertainty and the financial markets, lasted only a few weeks. The global business climate has even rebounded since April, and global financial conditions have improved with new stock market records, lower credit spreads, and lower volatility (cf. chart 2).

The strategic retreats made by the US administration in response to the sharp decline on Wall Street in the spring, and then in the face of China's strong position thanks to its virtual monopoly on rare earths, explain part of the phenomenon. The increase in tariffs remains substantial, but economic forecasting models, calibrated on the experience of the 2018-2019 trade war, have clearly overestimated its psychological effect on growth.

Finally, and perhaps most importantly, Trump's return to the White House and the brutality of his trade war have triggered countermeasures with beneficial effects. This is particularly the case in Europe, where external pressure from Russia, China, and finally the US has led to a healthy dose of introspection. In Germany, the taboo of the “Schwarze Null” – the constitutionally enshrined balanced budget – has been broken. Berlin has launched an ambitious civil and military spending plan. And the Draghi plan, which was given up for dead last year, is resurfacing in political discourse. These reactions to external pressures are paving the way for economic recovery in Germany in the coming quarters. They are also fueling risk appetite in the eurozone financial markets, which was not a foregone conclusion given the political and budgetary uncertainties in France. A new, more favorable financial cycle is therefore in the making which, if confirmed, will benefit the entire zone (cf. chart 3).

In this regard, Ms. Lagarde's press conference and the ECB's decision to maintain its interest rates on July 24, after eight cuts since June 2024, raise questions. No doubt counting on a reasonable conclusion to trade negotiations with the United States, the ECB president expressed confidence in the stability of the economy and downplayed the risks of inflation remaining below 2% for the long term. The low level of unemployment in Europe supports her view, but not the still too low level of overall economic confidence. Some ECB members, such as Olli Rehn and François Villeroy de Galhau, continue to favor a further rate cut.

Europe cannot afford to be complacent. The trade agreement with the United States will undoubtedly be a relief, but it will contain nothing positive, and US pressure will not let up. As for Chinese competitive pressure on key sectors such as the automotive industry, it will only increase. Europe must therefore rely on its domestic demand. This requires creating conditions conducive to a decline in household savings rates and accelerating the current financial cycle. With real interest rates (excluding inflation) at zero, the ECB is contributing to this virtuous circle, but it will need to remain vigilant.

Finally, on the US side, we may wonder what the agenda is now that Donald Trump is close to achieving his goals on tariffs and his budget bill has been passed. The ideal scenario would be one of moderate economic growth, which would allow the Fed to gradually resume its path of rate cuts in the fall, thereby alleviating fears about the budget trajectory. Interest expenses already account for more than 3% of GDP, the highest level in 30 years. But it is also possible that, buoyed by Wall Street's strong performance, Donald Trump will step up his disruptive policies and trigger a sharp decline in the dollar, with everyone taking steps to reduce their exposure to the United States. The final scenario is that the US economy picks up speed again, AI continues to boost Wall Street, and long-term rates rise. We will meet again in September to assess the conditional probability of these different scenarios...