Will Trump’s tariffs send inflation to a new high?

Investors have suffered painful losses in recent days after US president Donald Trump’s “Liberation Day” tariffs prompted a major market sell-off. Investors are concerned that tariffs will throw cold water on company earnings and broader economic growth.

The impact on inflation, particularly in the US, could also be significant.

According to economists at Goldman Sachs, each time the average tariff rate goes up by one percentage point, the rate of core US inflation goes up by around 0.1 percentage points.

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Ratings company Fitch estimates that the latest measures will raise the overall US effective tariff rate to around 25% – the highest rate in more than 115 years. Last year, the effective tariff rate in the US was around 2.3%.

Separate analysis from consultancy Capital Economics suggests Trump’s tariffs will push the effective tariff rate up by around 25 percentage points. As imports account for roughly 10% of consumption in the US, this could add roughly 2.5 percentage points to the CPI price level, the consultancy said.

Capital Economics expects US CPI to be “well north of 4%” by the end of this year, up from 2.8% in February. This would be a significant rise, but still lower than than the post-pandemic peak of 9.1% in June 2022.

Tariffs are a tax on foreign imports paid by businesses when they bring goods into the country. Companies typically pass these costs on to consumers by putting their prices up, which is why tariffs generally prove inflationary.

What tariffs has Trump imposed?

In recent days, Donald Trump has imposed sweeping “Liberation Day” tariffs of up to 50% on sixty countries, including a 34% tariff on China, 24% on Japan and 20% on the European Union. A baseline tariff of 10% is also being imposed on almost all foreign imports into the US.

This is on top of existing measures announced in February and March, including 25% steel and aluminium tariffs on all countries, a 25% duty on all cars made outside of the US, a 20% levy on China, and more.

As introduced previously, the effective tariff rate when all imports are considered holistically is now around 25%.

This will make any imports more expensive and push up the cost of any domestically-manufactured goods that include foreign parts. The dollar has also weakened since Trump’s latest tariff announcement on 2 April, which could exacerbate the inflationary effect in the US.

Will prices rise in the UK?

Given the interconnected nature of global economies, some form of contagion effect is possible, but it is currently unclear what this might look like.

For now, the UK appears to have got off relatively lightly compared to countries in Asia and the European Union. It has only been slapped with the metal tariffs, the car tariffs, and the baseline 10% universal tariff.

“It seems certain that the US will see marked price rises, but how far these tariffs will raise prices in the UK and Europe depends in part on whether there is any retaliation,” said Jason Hollands, managing director at wealth management firm Evelyn Partners.

“In a similar but less significant way to what occurred during the pandemic, it is likely that UK firms will see less choice and higher prices in goods that they source from overseas,” he suggests.

The picture is complex, though, particularly when you consider the fact that tariffs are also likely to dampen economic growth. In turn, this could prove deflationary. James Smith, developed markets economist at European bank ING, delves into this counterargument.

“The fact that the government hasn’t retaliated to the US tariff announcement thus far means the impact should be minimal,” he said. “If anything, it could prove deflationary further down the line as economic growth cools and the threat of dumping from other big global producers rises.”

How will central banks respond?

When the Bank of England met to set interest rates in March, it discussed the potential fallout of Trump’s looming tariff announcement, and indicated that it would take a wait-and-see approach.

While it acknowledged that tariffs could skew growth risks to the downside, it said the overall effect on UK inflation was “less clear”, and would “depend on where other countries’ trade policies settled and how these transmitted through different economic channels, including exchange rates”.

Since Trump’s tariffs were announced on 2 April, markets have adjusted to price in a faster pace of interest rate cuts, but this is largely being driven by weaker growth expectations.

There is also a degree of uncertainty when it comes to the US Federal Reserve.

“Whilst the negative impact on growth due to trade barriers seems clear, the impact on inflation and therefore the response of central banks is much less so,” said Andrew Chorlton, chief investment officer for fixed income at M&G, the investment management firm.

“This is probably best exemplified by the chair of the Fed's recent comments in early April, stating that he felt the impact on inflation of any increase in tariffs would be transitory in nature, i.e. a one-off jump in prices.

“Just a few days later on Friday, he acknowledged that the impact of tariffs on both inflation and employment is unclear and that he is taking a wait-and-see approach.”