Assessing the effect of tariffs

Assessing the effect of tariffs

First the good news. US tariffs are settling at lower levels than had seemed likely in early April. Negotiations with trading partners, including the EU, Japan, the UK, have resulted in the average US tariff on goods imports dropping from the 28% rate president Donald Trump announced on 2 April to 18.6% today.

• The bad news is that this is a sizeable shock to the global trading system, with far higher tariff rates than economists had expected at the start of the year. US tariffs have risen sevenfold since January to the highest level since the 1930s.

• Tariffs tend to raise inflation, squeeze consumer incomes and depress growth. Yet the US has defied the direst economic predictions. Inflation is under control, the economy is growing, the equity market is booming and federal revenues from tariffs have surged.

• Could the US be winning on tariffs? This week’s briefing assesses the evidence. 

• Tariffs have not caused a spike in inflation. At 2.7% in June, inflation was below levels seen over most of the last year. Forecasts for US inflation next year haven’t changed much since January – not what one might have expected given how far US tariffs have risen.

• Prospects for US growth have certainly weakened since April, with economists paring back their forecasts for GDP growth. But talk of recession, which was widespread in spring, has dried up, and in the last couple of months economists have nudged up their US growth forecasts. The general expectation is that US growth will outpace every other G7 economy this year and next.

• Investors have flocked into US stocks since Mr Trump announced a 90-day pause in tariffs on 9 April. US equities have outperformed other major markets, and are up 26%, with the S&P 500 hitting an all-time high.

• US government revenues from tariffs have surged, fulfilling what Mr Trump sees as one of the main aims of the policy. The Budget Lab at Yale, an academic think tank, estimates that higher tariffs will raise $2.1tn between 2025 and 2034, enough to finance about 60% of the cost of the administration’s tax cutting ‘One Big Beautiful Bill’ which passed into law last month.

• Retaliation against US tariffs has been limited and the world has not descended into a trade war. Several major trading partners have accepted US tariffs, some grudgingly. German chancellor Friedrich Merz said the US-EU trade deal would "substantially damage" his nation's finances, while French prime minister Francois Bayrou said it was tantamount to "submission".

• Some trading partners have also agreed to increase investment in the US and their purchases of US products. The EU has undertaken to buy $750bn energy products from the US over the next three years, up from a current rate of $75bn a year, and to invest $600bn, including in US defence equipment. Saudi Arabia, UAE and Qatar have pledged significant new investments.

• An array of companies – including Apple, Meta, Softbank and the world’s largest semiconductor manufacturer, TSMC – have announced new investments in the US in recent months. The Trump administration sees this as furthering its aim of bringing manufacturing back to the US.

• Yet it would be premature to declare that tariffs have been a success for the US economy.

• Although tariff rates have risen, their full effect has yet to be felt. Decisions by companies on margins and stock levels have significantly softened the initial impact of tariffs on the US economy.

• Goldman Sachs estimates that US businesses have absorbed around three-fifths of the extra cost duties that have been seen so far. Foreign suppliers are also bearing some of the load. Given the chopping and changes in tariff policy since 2 April, with rate rises, cuts and pauses, businesses may have been hoping for a reprieve and, therefore, prepared to absorb some of the cost. For US companies the prospect of lower business taxes, courtesy of the ‘One Big Beautiful Bill’, has probably helped. In any case squeezing margins is no free lunch for the economy since they weigh on corporate spending, investment and risk appetite. 

• The other mitigating factor is the role of stocks, or inventories. US companies stepped up imports and built up stocks ahead of Mr Trump’s ‘liberation day’ announcement. Those tariff-free goods have been feeding into the market and have cushioned the impact of tariffs on consumers.
   
• Stockpiling, the 90-day pause in the application of tariffs and a squeeze on corporate margins mean that the actual tariff rate paid by US consumers has lagged well behind the headline, average rate, which now stands at 18.6%. Tariff-free stocks will run out and there are limits to how far margins can be squeezed. In the coming months, the effect of higher tariffs is likely to become increasingly apparent to US consumers and businesses and in the inflation numbers. Tariffs are already showing up in the price of some items including car parts and furniture. Economists expect headline inflation to drift up from 2.7% in June to 3.4% by December.
   
• US activity may not have collapsed, but prospects have weakened since April’s tariff announcement. The US is likely to grow at about half last year’s rate in 2025. The jobs market is cooling, and US activity is distinctly lopsided. Deloitte’s chief economist in the US, Ira Kalish, points out that in the first half of 2025 technology investment, mostly related to AI, accounted for 59% of US growth. Enthusiasm about AI has also powered US equities higher since April’s low, with the big tech stocks, far outpacing the rest of the market.
   
• The effect of hiking tariffs to 18.6% is yet to fully feed through to US businesses and consumers. A more complete picture will emerge in coming months. But it’s hard to see why the effect of such large tariff increases would deviate from the past pattern of increasing prices, reducing consumer choice and weakening growth.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.3% at 9,096. The price of gold futures contracts reached a record high following the news that gold will now face US import tariffs.

Economics

• US president Donald Trump threatened to impose a 100% import tariff on semiconductors but said companies could avoid the levy by investing in the US
• Mr Trump announced an additional 25% tariff on imported goods from India over its purchases of Russian oil, taking the total tariff rate on Indian goods to 50%. The tariffs are an attempt to reduce Russian oil revenues and pressure Moscow into a ceasefire with Ukraine
• The US government will apply tariffs to one-kilo gold bars, sending gold futures prices sharply higher and dealing a blow to Switzerland as the world’s largest gold refining hub, the FT reports. The US government said it will provide clarification regarding gold tariffs in the near future
• Switzerland’s president and economy minister travelled to the US to “present a more attractive offer” as it seeks to lower the country’s 39% import tariff rate imposed by Washington
• The EU halted its proposed retaliatory tariffs against the US that were due to take effect from last Thursday following the initial agreement of a trade deal that will see a base rate import tariff of 15% on EU goods exports
• Mr Trump nominated Stephen Miran, chair of the White House’s Council of Economic Advisors, to the board of the Federal Reserve. Mr Trump also said that Kevin Hassett, director of the National Economic Council, and former Fed governor Kevin Warsh, are the leading contenders to be the next Fed chair
• The Bank of England cut interest rates by 0.25 percentage points to 4%. BoE governor Andrew Bailey said the decision was “finely balanced,” with only five of the nine members in favour of the rate cut. Investors subsequently pared back expectations for future rate cuts
• The Bank forecasts UK inflation to peak at 4% in September and remain above the 2% target rate for most of the next two years. BoE deputy governor Dave Ramsden said he was “surprised” by the persistence of inflation
• The UK government will face a £41bn gap in the public finances by the Autumn Budget later this year, according to the National Institute for Economic and Social Research think tank, increasing the likelihood of future tax rises
• FT analysis shows that about 3,800 company directors have left the UK since the Autumn Budget last year that abolished the non-domiciled tax regime and raised other taxes on wealthy individuals
• Approximately half of UK businesses expect staff to be ‘on site’ all the time, up from 27% two years ago, signalling a shift away from home working, according to the British Chambers of Commerce
• UK house prices increased by 0.4% in July compared with the previous month, after near flat growth in June following the end of the stamp duty holiday, according to Halifax
• The OECD warned that business investment is lower than pre-pandemic levels and well below rates seen before 2008. OECD chief economist Álvaro Pereira said countries would “not be able to sustain growth” if investment does not pick up

Business

• Apple said it will increase its investment in the US by $100bn to a total of $600bn over the next four years. Mr Trump said Apple would avoid the incoming semiconductor tariffs because of the investment
• Technology company Palantir recorded revenues of $1bn in the second quarter this year, nearly 50% more than in 2024, which it attributed to the booming AI industry
• US construction equipment maker Caterpillar warned of a potential $1.5bn hit to profits from US import tariffs this year, as it posted a fall in earnings in the second quarter
• Shares in investment giant Berkshire Hathaway have fallen 14% since May, compared to an 11% gain in the overall S&P 500 index, following chief executive Warren Buffett’s retirement announcement
• BP made its largest discovery of oil and gas reserves in 25 years. The field, located off the coast of Brazil, could be a multi-billion-barrel site but could take up to ten years for production to begin
• The UK Supreme Court ruled that car dealers do not owe a “fiduciary duty” to customers, reversing part of a previous judgement by the UK Court of Appeal that threatened the UK banking sector with up to £44bn of compensation payments. The ruling means compensation payments are likely to be less £20bn
• UK sales of Tesla vehicles fell 60% in July compared with the same month last year amid low electric vehicle demand and increasing competition from Chinese rivals such as BYD
• Mining company Glencore scrapped plans to move its primary stock market listing from London to New York, providing a boost for London’s stock exchange that has recently seen several businesses switching to list in the US
• Visa is closing in on a deal to move office locations to Canary Wharf, the FT reports, while HSBC announced it will continue leasing office space in the business district for another 15 years. Both decisions defy the recent trend of high-profile organisations leaving the area

Global and political developments

• Israel’s security cabinet approved a new military offensive in Gaza to take control of Gaza City and lead to the creation of “a civil administration for the entire enclave”
• President Trump and Russian president Vladimir Putin will meet in Alaska on 15 August. Mr Trump said a peace deal between Russia and Ukraine might involve “some swapping of territories”. European leaders, including the UK and France, issued a joint statement saying Ukrainian borders “must not be changed by force”
• The Spanish government said it will replace its current fighter jets with European-made aircraft, rather than the US-made F-35 fighter jets, amid increasing tensions between the US and Spain over the latter’s defence policy
• UK deputy prime minister Angela Rayner demanded further information from Chinese authorities over plans for its new embassy in London after Beijing initially submitted plans containing redacted drawings, the FT reports
• The General Medical Council, the UK’s medical regulator, called for reforms to training and career progression as it warned that nearly 20% of doctors are considering leaving the profession while a further 12% are considering moving abroad

And finally… a disgruntled bishop in Holborn, London, interrupted an evening church concert by turning off the lights and asking the choir singers to stop their “terrible racket” and leave his house – choir-ten down