What is the impact of potential Trump 2.0 on Europe? By Investing.com

The likelihood of a second Donald Trump presidency is increasing, with prediction markets now assigning a 60% chance of his victory in November.

Given the significant economic and geopolitical shifts witnessed during Trump’s first term, a potential Trump 2.0 presidency could have profound implications for Europe, according to analysts at Goldman Sachs.

One of the most immediate impacts of a Trump re-election would be the reintroduction of aggressive trade policies. Trump has pledged to impose a 10% tariff on all U.S. imports, including those from Europe. This would likely lead to heightened trade policy uncertainty, similar to what was experienced during the 2018-2019 trade war with China.

“We estimate a statistical model using monthly data since 1987 to show that higher trade policy uncertainty tends to have large and persistently negative effects on Euro area activity, while the repercussions of actual tariff increases are more muted and more difficult to identify,” the note states.

Specifically, the previous trade war lowered Euro area industrial production by around 2%, contributing to a 1% GDP decline. If Trump imposes these new tariffs, the EU is expected to retaliate, escalating the trade tensions. Analysts also note that European economies, especially Germany, would be particularly vulnerable due to their high reliance on trade and industrial activity. The increased tariffs could boost inflation slightly, but the primary effect would be a slowdown in economic growth.

Another significant area of impact would be defense and security.

Trump has consistently pushed for NATO members to increase their defense spending to 2% of GDP. European countries currently spend about 1.75% of GDP on defense, so meeting Trump’s demands would require an additional 0.25% of GDP annually.

Furthermore, Trump’s stance on reducing U.S. military support to Ukraine could force European nations to increase their spending by another 0.25% of GDP.

While it could provide a modest boost to growth, the high import share of European military spending means that much of this boost would benefit the U.S. economy instead. Moreover, increased deficits could put upward pressure on long-term interest rates in Europe, potentially offsetting any growth benefits.

Trump’s domestic policies, particularly tax cuts and deregulation, could also have spillover effects on Europe. Increased U.S. demand resulting from these policies might slightly lift Euro area activity. However, the financial market shifts seen after Trump’s 2016 election—higher long-term yields, rising equity prices, and a stronger dollar—are expected to be less impactful this time.

“The net financial spillover, however, would likely be muted as we would expect the effect of higher long-term rates to be offset by a notably weaker Euro, consistent with the post-election moves in November 2016.”

“Taken together, our estimates suggest that Trump’s policy agenda would lower Euro area GDP by around 1% and boost inflation by 0.1pp,” they added.

“Given a larger (and more persistent) effect on activity than on inflation, we would expect Trump’s re-election to strengthen the case for continued ECB rate cuts in 2025, with simple Taylor rules pointing to additional cuts worth 30-40bp.”