Tariffs threatened to be a third inflation shock for Europe, but have had little impact

For Europe’s central bankers, President Trump’s tariff blitz has been a bit of a nonevent.

Since the tariffs were introduced in early April, the European Central Bank has lowered its key rate twice and to the point where policymakers judge it is no longer restraining economic activity, but gone no further.

The Bank of England is on a path to that neutral destination, but maintaining the same steady pace it adopted well before the tariffs were announced. Even Switzerland, which faces some of the highest tariffs to be levied by the president, has declined to hit the panic button.

What at one point seemed set to be a third big inflation shock this decade—after the Covid-19 pandemic and Russia’s full-scale invasion of Ukraine—appears to have been of little consequence for consumer prices, or monetary policy, at least not yet.

The ECB last week signaled that it is not expecting to change its key interest rate again this year, even as the 15% tariff that the U.S. has imposed on most imports from the eurozone ripple through the currency area’s economy.

In a speech in Finland, President Christine Lagarde laid out the ECB’s understanding of what just happened, or didn’t happen. Most importantly, European governments decided not to retaliate when Trump imposed tariffs. If they had, prices of goods imported from the U.S. would have risen, fueling inflation.

The other thing that didn’t happen was a depreciation of the euro. Ahead of their imposition, most economists predicted that the euro would lose ground after tariffs were applied, since the demand for eurozone exports would cool, as would demand for the currency in which they were sold. Instead, the euro has gained significantly since the start of the year.

“All in all, with no retaliation and an appreciating exchange rate, tariffs have had little inflationary impact so far, with their adverse effects mainly limited to growth," said Lagarde. “Those effects, however, have been relatively moderate thanks to the domestic response."

Included in that response has been a series of trade deals with economies around the world, most recently with Indonesia. The ECB calculates that deals sealed to date cover 3% of eurozone exports, and those in the pipeline a further 6%. In 2024, 21% of EU exports went to the U.S., and most of those are now subject to higher tariffs.

For Lagarde, EU governments chose not to retaliate against Trump’s tariffs partly because it was more important to them to retain his support for Ukraine in its defense against Russian invasion. And the dollar’s weakness largely reflects doubts about whether the currency “would continue to warrant its status as the ultimate safe-haven currency," Lagarde said.

In sum, various Trump effects have cancelled each other out as far as inflation in Europe is concerned.

If anything, big changes in trade policy have had an even smaller impact on the calculations of rate setters at the BOE. In a speech last week that was entirely about the recent path of, and outlook for inflation, Deputy Governor Sarah Breeden made not a single reference to tariffs.

That isn’t a case of British discretion. The BOE has much bigger worries, and particularly a largely home-made pickup in inflation to twice its target level.

The impact of tariffs on inflation may not be complete.

In particular, Chinese businesses facing high duties in the U.S. could seek new customers in Europe, and lower their prices to acquire them, putting downward pressure on inflation as well as economic growth. At least one ECB rate setter thinks it likely that supply chains will be disrupted, leading to a repeat of the pickup in inflation that accompanied the second year of the Covid-19 pandemic, if on a smaller scale.

But the ECB’s economists reckon either development would have a very modest impact on prices, with inflation in 2027 coming in as high as 2.1% or as low as 1.7%, compared to the 1.9% now forecast.

That is not a rate-changing deviation from the target, and it may take an entirely different shock to really change the outlook for European policy rates.

Write to Paul Hannon at paul.hannon@wsj.com