EU Trade Deal with the U.S. Likely, but 20% Tariffs Would Further Raise Economic Risks and Strain Public Finances

The U.S. administration delayed the implementation of reciprocal tariffs from July 9th to August 1st. There is still a likelihood of a potential 'agreement in principle' between the U.S. and the European Union (EU) to fend off a further increase in tariffs and allow for negotiations to continue. Nevertheless, if no deal is reached, the EU could face an increase in tariffs to 20%, as originally announced, or potentially even higher if tensions escalate. In this exercise, we expect slower economic growth in the EU, which could lead to slower fiscal repair and more difficult debt-to-GDP ratio reductions for countries already facing economic struggles and higher spending due to the newly agreed NATO defence spending target.

Key Highlights

-- The current tariff level is already significantly impacting European economies.
-- If European countries were unable to strike a deal ahead of the deadline, the economic landscape would significantly deteriorate posing further strain on public sector accounts.
-- The largest European economies may be able to withstand the challenges imposed by the trade war using fiscal space or given the high quality of their exports to the U.S.

"If no deal between the U.S. and the EU is reached, steeper tariffs will slow down further the major European economies. This, coupled with heightened defense expenditures, could slow deficit reduction efforts and make stabilising or decreasing debt-to-GDP ratios more difficult, " said Javier Rouillet, Senior Vice President, Morningstar DBRS, Global Sovereign Ratings.