• Just as optimism around the economic outlook had started to improve, Europe suddenly finds itself back in a tariff fight with the US. That said, we have learnt not to overreact to Trump’s trade threats and details are still thin. European policymakers will look to defuse the situation through dialogue and the provision of off-ramps, while the pending US Supreme Court ruling could also change the picture.
• However, escalation risks seem higher with initial reactions suggesting an increased willingness among some European officials to retaliate forcefully. The likely postponement to ratification of the previous trade deal may become another flashpoint.
• Even in the case of a negotiated outcome, tariff uncertainty is set to remain higher now. The wider geopolitical implications of Trump’s apparent territorial ambitions could also become lasting headwinds for business sentiment. While the euro area economy carries reasonable growth momentum into 2026 and has demonstrated a degree of resilience to the US initial tariffs, nobody wins in a trade war. This is set to be the first major test for the ECB and its “good place” narrative.

Heightened uncertainty will test the economy’s resilience

The return of trade uncertainty (did it ever really disappear?)

It hasn’t taken long for hopes for a period of relative economic stability in Europe at the start of the year to evaporate. Trump announced that he will impose a new 10% tariff on eight European countries (Denmark, Germany, France, the UK, the Netherlands, Finland, Norway and Sweden) until a deal for the US purchase of Greenland is reached. These tariffs will apply from 1 February and rise to 25% on 1 June if no deal is agreed.

As ever with Trump the details are thin on the ground – it’s not clear what legal framework would be used, nor how this would relate to the existing US reciprocal tariffs. Stacking the new tariff on top would initially take US tariffs to 25% for the EU countries and Norway, and 20% for the UK, before rising to 40% and 35%, respectively, from June. The domestic US legal challenge over the application of reciprocal tariffs adds to the uncertainty with a US Supreme Court ruling possible this week.

The last year has taught us not to overreact to Trump’s threats. European policymakers will look to pursue dialogue and negotiation first, starting in Davos this week, in the hope of at least buying some more time. There could be an off-ramp for Trump if the current framework is ruled illegal in the meantime (‘the courts have tied our hands’). Europe will likely try to offer Trump other avenues for de-escalation such as commitments to deepening investment in Arctic security.

Risks of escalation seem higher than last year

It’s not obvious that this approach will bring success if Trump is fundamentally attached to the idea of US territorial expansion. Initial comments also suggest that a line has been crossed for many European officials with this latest move. The risk of meaningful escalation seems a degree higher than it was in the summer when the EU ultimately swallowed an unbalanced trade deal (our initial take on that here).

That agreement was a case of pragmatism over principle, with the EU seeking to prioritise certainty and reduce downside risks. So much for that. The deal itself has still not been ratified by the European Parliament and the president of the European People’s Party (EPP), the largest group, has said it will not be approved while tensions remain elevated, which could further provoke Trump.

The lopsided nature of last summer’s trade deal underscored Europe’s continued reliance on the US, particularly in defence. That still holds and it is plausible that the EU could again just swallow these tariffs without a fight.

But if the EU does pursue economic countermeasures then it has two broad options: (1) retaliatory tariffs, or (2) the use of the broader Anti-Coercion Instrument (ACI).

Goods tariffs would be more straightforward – the European Commission has already readied possible targets covering a reported 93bn EUR of goods and measures are set to automatically kick in on 6 February after a six-month suspension.

The ACI, meanwhile, is seen as the more extreme ‘big bazooka’ option which would give policymakers broad scope to take countermeasures beyond goods trade and into areas such as EU imports of technology services. Several policymakers, including the French president and German vice chancellor, have discussed using the ACI if Trump were to follow through with his threats, but we still see it as the less likely option.

A test of the economy’s resilience

Earlier this month we set out our outlook for the euro area economy: growth close to potential, neutral monetary policy, inflation marginally below target. We acknowledged that it was a disconcertingly simple story with US policy volatility and tariff uncertainty high on the list of risks.

Even setting aside the obvious risks for further escalation, it should be stated that any of the countermeasures listed above would entail economic pain for Europe.

But it’s worth repeating that the European economy has demonstrated a degree of resilience to the initial US tariffs, and that German fiscal stimulus will provide a significant cushioning effect this year. In the case of significant escalation, we’d expect a more forceful fiscal response, both at a national and EU level. The recently-agreed Mercosur trade deal will also boost growth, at the margin.

We also highlight that, if higher tariffs are implemented on just a handful of EU member states as threatened, it would be extremely difficult for US customs officials to enforce rules of origin. There would be obvious scope for re-routing of trade to reduce exposures to selective US tariffs (we imagine Belgian ports would be busy).

However, the potential for differing US tariffs between EU member states (and hence scope for circumvention) likely only applies if the new US tariffs are applied and the EU rolls over again without reacting. In the case of any EU retaliation, we assume that the US would broaden the scope of higher tariffs to the whole bloc.

More broadly, this development is likely to set to weigh on sentiment, even if tensions are defused. Depending on the survey date, some of this might be captured in Friday’s flash PMIs for January. As well as the issue of tariffs themselves there are plainly huge implications for the Western military alliance, which could have a lasting impact on business confidence. And even if there is de-escalation this episode will still cause many to doubt the credibility of any deal with Trump and so tariff uncertainty will remain elevated.

Another immediate risk for Europe relates to energy prices. Natural gas prices rose sharply last week on fears around European storage levels and the potential for a protracted period of cold weather. The US accounts for around a quarter of all EU gas imports and would be clearly vulnerable to US policy changes such as export controls.

Against this backdrop the ECB might struggle to maintain its ‘good place’ mantra. Nobody wins in a trade war. While any retaliatory measures from the EU could clearly push up consumer prices, ultimately the impact on demand from tariff escalation is likely to be disinflationary, which supports our view that further easing is more likely than policy tightening this year.