How will Europe respond to U.S. tariff threats?

Analysis
Insights

For the European Union, the economic impact of U.S. tariffs will depend on their level and duration. We investigate the implications of rapidly changing U.S. trade policies, and explore how the EU may respond.

Share

February 20, 2025

Frédérique Carrier
Managing Director, Head of Investment Strategy
RBC Europe Limited

Surveying the tariff landscape

The European Union (EU) is finding itself in the crosshairs of a trade dispute with the United States. RBC Global Asset Management Chief Economist Eric Lascelles points out that although no individual European country is among its three largest trading partners, collectively the EU is the largest consumer of U.S. products and, at the same time, maintains a trade surplus with the U.S. – meaning the region exports even more than it imports.

Trump tariff targets are top U.S. export destinations

U.S. goods exports (% of total exports)

U.S. goods exports by destination

The column chart shows the percentages of U.S. goods exports directed to the countries that consume the most U.S. goods. The European Union (EU) consumes 17.9% of U.S. goods exports; Canada, 16.9%; Mexico, 16.2%; China, 7.0%; the United Kingdom, 3.9%; Japan, 3.9%; South Korea, 3.2%. Within the European Union, the Netherlands consumes 4.3%; Germany, 3.7%; France, 2.1%; Italy, 1.6%; Spain, 1.2%; Ireland, 0.8%; and other EU countries combined, 2.6%.

As of December 2024; 12-month moving total of share of U.S. goods exports by destination.

Source – RBC Global Asset Management, U.S. Census Bureau, Macrobond

Reciprocal tariffs

U.S. President Donald Trump’s most recent idea for rectifying what he views as an unfavourable balance of trade is to impose reciprocal tariffs, whereby a country matches the tariffs that trade partners charge. Such tariffs would potentially have a much larger negative impact on the European economy than the targeted tariffs on steel and aluminium the U.S. recently announced.

Trump has tasked U.S. trade officials with examining all trade partners’ tariffs (as well as non-tariff barriers such as regulations, government subsidies, and sales taxes) with an eye toward charging countries similarly. In the case of the EU, potentially contentious regulations include limits on genetically modified organisms and hormone-treated meat, while a wide range of subsidies help support its agricultural sector.

U.S. trade officials will also focus on whether the value-added tax (VAT) system should be viewed as an additional tariff on U.S. exports.

The VAT is an approach to taxing consumption that is used by some 175 countries around the world. It is applied on all goods at the point of consumption, regardless of whether they are produced domestically or imported, a fact that underpins arguments against classifying it as a tariff. Nonetheless, opponents have long argued that the VAT unfairly impacts U.S. exports.

At an average rate of roughly 20 percent, the VAT is an important source of funds for the EU, accounting for approximately one-fifth of tax revenues. Hence, it is unlikely to be decreased, in our view.

U.S. officials are due to present their findings by April 1. If the U.S. were to impose reciprocal tariffs that include VAT rates, the EU could be hit by tariffs as high as 25 percent. Such an outcome would be negative for the European economy, though the impact would depend on how long such tariffs remain in force.

Targeted tariffs

The Trump administration has imposed 25 percent tariffs on steel and aluminium imports into the U.S. starting March 12, 2025. Lascelles thinks the maximum economic impact of targeted tariffs is likely to be relatively small, but he sees a high risk that these tariffs could persist indefinitely. This is because the U.S. administration sees tariffs as a means to fund tax cuts, at least partially, as well as to protect American businesses from foreign competition.

The EU’s options: fast and flexible?

The European Union’s trade policy is the remit of the European Commission (EC), which negotiates and ratifies international trade agreements. Individual member states do not enter into bilateral trade agreements.

Until 2023, the EU had no centralised mechanism to respond quickly to economic policies it viewed as coercive. Any ad hoc retaliation required unanimous agreement, and included waiting for a World Trade Organization ruling or lengthy negotiations among member states.

To formalise and speed up its response process in trade negotiations, the EU in 2023 put in place an Anti-Coercion Instrument (ACI) that requires only a “qualified majority” or the approval of 15 out of 27 member states, representing 65 percent of the bloc’s population.

The ACI also provides a wider range of countermeasures than were previously available; beyond tariffs, the EU can impose investment restrictions and procurement bans, among other economic tools. Though the process of responding to trade policy changes can still take up to eight weeks, the ACI enables the EU to impose countermeasures faster and with greater flexibility.

If the U.S. were to impose tariffs, the EU would likely offer concessions as a first response. It could increase U.S. liquified natural gas imports, and/or boost military spending as the governments of the three largest EU economies (Germany, France, and Italy) currently spend less than 2 percent of national GDP on defence. It could also offer to lower trade barriers; for instance, the EU levies a 10 percent tariff on motor vehicles produced in the U.S., while EU vehicles are subject to a 2.5 percent U.S. tariff.

But the EU would also eventually retaliate, in our view. The EC has stated it would respond “firmly” to U.S. tariffs, but the ones it might impose would likely be less punitive than those imposed by the U.S. Many European policymakers have argued for negotiations instead of retaliation. European Central Bank President Christine Lagarde has called for talks and Friedrich Merz, likely to be the next chancellor of Germany, suggested before the U.S. presidential inauguration that the EU should continue free trade discussions.

A strategy of de-escalation served Europe well in 2018. Faced with similar tariff threats, the EU increased its U.S. liquified natural gas purchases and responded to tariffs on European exports worth more than $6 billion with tariffs on U.S. goods for half that amount, targeting whiskey, blue jeans, and motorcycles.

This approach helped to defuse trade tensions with the first Trump administration. A similarly measured response by the EU could reduce the risks of trade war escalation, in our view.

A serious threat to regional recovery

Europe’s tentative economic recovery is likely to be tested by tariff threats. Given the Trump administration’s goal of increasing tariff revenues to help fund domestic tax cuts, these threats should be taken seriously, in our view, and we would look to position portfolios for increasing trade tensions and high volatility.

For European stocks, earnings risk may be mitigated by the fact that many companies have manufacturing facilities in the U.S. We would continue to focus on global leaders that benefit from – and drive – structural global trends, particularly in semiconductor manufacturing equipment, electrical and mechanical engineering, industrial gases, and health care.

Let’s connect


We want to talk about your financial future.


This publication has been issued by Royal Bank of Canada on behalf of certain RBC® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.

The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.

This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.

Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. Deposits made with Royal Bank of Canada (Channel Islands) Limited in Jersey are not covered by the UK Financial Services Compensation Scheme. Royal Bank of Canada (Channel Islands) Limited is a participant in the Jersey Bank Depositors Compensation Scheme. The Scheme offers protection for ‘eligible deposits’ up to £50,000 per individual claimant, subject to certain limitations. The maximum total amount of compensation is capped at £100,000,000 in any 5 year period. Full details of the Scheme and banking groups covered are available on the Government of Jersey’s website www.gov.je/dcs or on request.


Frédérique Carrier

Managing Director, Head of Investment Strategy
RBC Europe Limited

Related articles

Pay attention to triggers for Europe

Analysis 6 minute read
- Pay attention to triggers for Europe

The end of China’s challenging chapter?

Analysis 7 minute read
- The end of China’s challenging chapter?

Exploring the impacts of AI and GenAI across industries

Analysis 14 minute read
- Exploring the impacts of AI and GenAI across industries