Tariffs and uncertainty - implications for growth and inflation

14 April 2025

Last week global equity markets staged a partial recovery after president Trump announced that most higher rates of tariffs announced the previous week would be postponed for 90 days pending negotiations. The S&P500 jumped 9.5% on the news.

When there’s turmoil in financial markets, investors usually seek the safety of US Treasury bonds. But last week they sold off, triggering concerns that stress in the world’s safest, most liquid asset could spark problems in other parts of the financial system. Despite a relief rally after Mr Trump’s announcement, markets remain edgy. US equities sold off on Thursday and Friday, Treasury yields remain close to last Wednesday’s highs and the US dollar has sunk to a three-year low against the euro.

The highest tariffs have been postponed for most countries, but not China. A new 125% tariff on Chinese goods is in addition to the previous 20% tariff, taking the rate to 145%. Most countries face a 10% tariff, though cars, steel and aluminium are subject to 25% tariffs and goods from Mexico and Canada not covered by the USMCA trade deal pay 25%.

However, US commerce secretary, Howard Lutnick, suggested yesterday that these products would be subject to semi-conductor tariffs “in probably a month or two.”

The 90-day delay in the implementation of higher tariffs, above 10%, is a temporary reprieve for most of America’s trading partners but not for the US consumer. Much higher tariffs on China, America’s largest trading partner, mean that the overall tariff rate on US goods has risen as a result of last Wednesday’s changes, to 27% according to the Yale budget lab (YBL). This is a ten-fold increase in tariffs since the start of the year and takes tariffs to the highest level since 1903. (The YBL figures exclude the effects of Friday’s exemption of consumer tech from tariffs).

The Petersen Institute for International Economics, notes that US tariffs on Chinese products are more than 40 times higher than before the US-China tariff war started in 2018 and six times higher than when the second Trump administration began in late January. With a tariff rate of 145% many US consumers and businesses will simply switch away from Chinese products.

YBL has modelled a decline in China’s share of US imports from a current 14% to 4%, which, by reducing China’s weight in calculating the overall tariff rate, would give a lower effective rate of 18.5%. The redirection of spending away from imports subject to the highest tariffs lowers the effective tariff rate but leaves US consumers and business paying the highest tariffs since 1930.

Tariff increases have already taken effect and are likely to feed through quickly into prices. Given that goods imports account for about 11% of US GDP the effects are likely to be material. The YBL estimates that tariff rises imply a 2.9% increase in consumer prices at a time when US inflation is running around the 2.5% mark.

The pause in higher rates of tariffs leaves what Sarah Breeden, deputy governor for financial stability at the Bank of England, described last week as “the chilling effect of trade policy uncertainty on firms and consumers.” Unprecedented is an overused word, but it feels right today. A measure of policy uncertainty created by US academics, shows US trade policy uncertainty reaching the highest level in the index’s 40-year history in March (this reading was taken before the announcement of universal tariffs and then their partial postponement). Last week Deutsche Bank summed up the challenges as, “crippling policy uncertainty, haphazard tariff rate calculations [and] a partial loss of confidence in US institutional norms.”

Uncertainty weighs on financial markets, confidence and activity. These effects were on display in financial markets last week, with institutions shifting at pace into safer, more liquid assets. Unchecked, such moves tend to result in a tightening of credit conditions for households and corporates.

Recent events have fed through to US consumers. The Michigan consumer confidence reading for April, released on Friday, showed confidence at the second lowest level since the series started in 1978. US consumers are braced for a surge in inflation, with expectations for US inflation in one year’s time rising to 6.7%, the highest reading since 1981. Expectations for unemployment rose to the highest level since the financial crisis in 2009, a year which saw US unemployment peak at 10%.

Households tend to react to uncertainty by building up savings and delaying consumption, particularly on ‘big ticket’ items such as cars and home refurbishment.

Businesses react in a similar way. A 2013 Bank of England paper noted how uncertainty delays production and investment decisions and causes some of most productive firms to delay entering new markets at home and overseas. Uncertainty also encourages employees to sit tight in their current jobs, and deters firms from hiring, outcomes which, the Bank observes, weakens the matching function of the labour market and undermines productivity.

Brexit provides a case study in the impact of uncertainty on business. In 2019 the Bank of England used data from Deloitte’s CFO Survey to examine the relationship. In a speech drawing on the research, Michael Saunders, then a member of the Bank’s Monetary Policy Committee, noted that CFOs who reported elevated levels of uncertainty were far less likely to prioritise expansionary strategies such as increasing capital expenditure. The impact on investment is likely to have been material. In 2023 the UK’s National Institute for Economic and Social Research estimated that Brexit had reduced the level of UK business investment by over 12%.

Our latest UK CFO Survey, released today, shows that even before the announcement of universal tariffs on 2 April, UK CFOs had become more defensive, with a heightened focus on cost control (the survey period ran from 18-31 March). CFOs identify geopolitics, including tariffs, as the biggest external risk facing their business, with cyber-attacks in close second place, while concerns about US growth have risen to the highest level since we first asked the question in 2020.

Economists have been scrambling to incorporate the effects of recent volatility and uncertainties into their growth forecasts with predictable results.

Consensus, or average forecasts for US GDP growth this year have fallen sharply, from 2.2% in February to 1.4% in April. This average includes forecasts made before last week’s events and is likely to fall further as economists revise their forecasts. Goldman Sachs, which, at the time of president Trump’s inauguration in late January, was forecasting US growth of 2.4% this year, last week downgraded its forecast to 0.5%. Goldman assigns a 45% probability to the US falling into recession this year.

Forecasts for most other major economies are declining, although the downgrades are smaller than for the US.

China faces by far the highest tariffs and is therefore likely to see its exports to the US decline precipitously. However, Chinese exports of goods to the US account for just 3.0% of China’s GDP suggesting that the impact of tariffs on the Chinese economy may be contained. Among major economies Mexico is most exposed to US trade (exports to the US make up 33% of Mexican GDP), Vietnam is in second place (25% of GDP) and Canada in third place (20% of GDP).

Uncertainty and disruption to trade tend, as the pandemic and its aftermath illustrate, to weaken growth and push up prices. But the effects are more chaotic and messier than this simple relationship suggests.

Imports into the US are likely to surge as companies and consumers seek to avoid even higher tariffs in three months’ time (The Financial Times reported last week that the cost of flying goods from China to the US has risen by almost 40% in the last four weeks). US households, despite being downbeat about the economy, are likely to pre-purchase goods which are due to face much higher tariffs.

It's a different story for China. With 145% tariffs Chinese exports to the US are likely to shrink quickly, causing disruption and supply bottlenecks. The Financial Times reports that shipping companies are facing a growing number of cancellations of transpacific orders, a trend which they expect to continue.

Reducing dependence on China, America’s main trading partner, is not straightforward.

In what seems like a clearcut case of economic ‘decoupling’ the US has already reduced its direct reliance on imports from China by approximately one-third over the last decade. But the gap left by Chinese exports has been filled by goods from alternative ‘connector’ nations, such as Vietnam and Cambodia. Much of which is being shipped to the US from such connector nations is either made in Chinese-owned factories or uses Chinese made components. A Federal Reserve study last year found that even as China’s share of US imports has declined, the proportion of imports into the US which were made in China or by Chinese-owned companies overseas has risen. On this measure the US has become more, not less dependent on China.

By committing themselves to rules, such as targeting a certain rate of inflation or signing trade agreements, governments aim to foster confidence and growth. Recent events are a reminder of the effects of sudden and significant rule changes.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 1.1% at 7,964, following another turbulent week of global trade announcements

Economics

Global financial markets had a turbulent week. The S&P500 equity index recovered slightly from earlier declines and yields on long-term US government bond rose to 4.5%
US president Donald Trump announced a 90-day pause on higher tariff rates against many nations. The majority of US imports now face a 10% levy, however steel, aluminium and automobiles face 25% tariffs
The US implemented higher import China in response to China’s retaliation to the US’ initial tariff announcements. Both nations increased levies against the other in a series of announcements last week. US duties against Chinese imports are now 145%, while Chinese duties on imports from the US are 125%
The Chinese government said it would “fight to the end” in the rising trade tensions with the US
US consumer price inflation softened by more than expected in the year to March to 2.4%, from 2.8% in February
US ports storing imported vehicles are expected to rapidly near full capacity in the coming weeks, as many car manufacturers increase inventories amid US import tariffs, the FT reports
The UK economy grew by 0.5% in February compared with the previous month, above expectations of 0.1% and the fastest monthly growth rate since March 2024
UK house prices unexpectedly fell by 0.5% in March compared with the previous month, according to Halifax, as buyer demand normalised following a surge in activity prior to the March stamp duty deadline
UK government long-term borrowing costs rose to their highest level since 1998 following a global bond market sell-off amid recent trade uncertainty. Borrowing costs across most major economies also rose
The UK government watered down its targets for electric vehicle adoption, including a longer period to phase out hybrid car sales and smaller fines for non-compliance
Euro area investor sentiment fell by more than expected to its lowest level since October 2023, according to the Sentix index, following recent global trade uncertainty

Business

The UK government has suspended import tariffs on 89 products and increased loans available to exporters to reduce pressures on UK business
The UK parliament was recalled to hold an emergency debate on nationalising UK steel maker British Steel, after the government failed to agree a financial support package with its current private owners Jingye Group
Car manufacturer Jaguar Land Rover paused car shipments to the US for one month following the US’ imposition of 25% import tariffs
US entertainment organisation Universal announced plans to build a theme park in Bedfordshire, to be opened in 2031. James Bond and Paddington Bear are among the attractions, the BBC reports
Luxury fashion brand Prada announced the purchase of rival brand Versace for $1.4bn
UK AI start-up Wayve announced a deal with carmaker Nissan to install its advanced driver assistance software
FS Italiane Group, co-owner of UK train operator Avanti West Coast, announced a €1bn plan to rival the current Eurostar service between London and Paris
The United Nations passed a plan to charge ships a minimum of $100 for carbon dioxide emissions surpassing an agreed decarbonisation target, despite retaliatory threats from the US on fees imposed on US-owned ships
Insurance company Legal and General, a large investor of energy company BP, said it was “deeply concerned” about BP’s pivot away from renewable energy investment

Global and political developments

US president Donald Trump said the US will hold high-level talks with Iran to discuss its nuclear arms programme
Ukrainian president Volodymyr Zelenskyy said that 155 Chinese nationals had signed contracts with Russia to fight against Ukraine
Germany’s incoming chancellor Friedrich Merz said a coalition deal has been reached between his Christian Democrat party (CDU) and the Social Democrats (SPD). The deal is yet to be approved by SPD members
Swiss president and finance minister Karin Keller-Sutter said that Switzerland wanted to “deepen relations with the EU”, while UK chancellor Rachel Reeves said an improved UK-EU relationship was “imperative” amid rising global tensions. Both finance ministers met with EU counterparts last week
The UK Cabinet Office said that nearly one-third of staff, totalling 2,100, would be cut or moved to another department amid wider government plans to boost public sector efficiency
The UK’s Reform Party said it would not form coalitions with the Conservative party in the upcoming local elections in May

And finally… a Harris hawk that had been terrorising residents of a Hertfordshire village for several weeks was finally captured by a local resident named Mr Harris.The bird of prey was responsible for more than 50 ‘divebombings’ against locals and the disruption of postal deliveries – jailbird

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