By Stefan Koopman, Senior Macro Strategist at Rabobank

The Trump administration’s decision to slap a 25% tariff on imported cars and parts is yet another move in America’s ongoing trade battles. Following the global steel and aluminum tariffs, this latest escalation puts pressure on the EU to respond. As we noted in a special report released yesterday, we believe the European Union prefers to make a deal and prevent a full-blown trade war. However, we argue that Brussels’ decision-making procedures are designed in such a way that escalation is ‘technically’ the path of least resistance. Therefore, absent an agreement, or a clear prospect thereof, European leaders will most likely strike back to any tariffs imposed by the US, even if not fully and with some delay.

We also show in this report that the use of the EU’s (so far never used) Anti-Coercion Instrument is an option open to the European Commission, especially if the US tops up this week’s measures with its already infamous reciprocal tariffs on April 2. This approach, however, would take more time, face more internal hurdles in the EU, and could provoke an even more severe counter-response from the US, one that may extend beyond economic statecraft to political or military actions. This complicates an already complex situation. Therefore, at least initially, we expect the EU to bundle its response in rebalancing measures, i.e., rebalancing tariffs. This enables the EU to react as quickly as possible. Additional countermeasures, such as quotas, will only be considered if the US implements tariffs so high that the EU cannot match the economic impact.

In our baseline scenario for the economy, we have long included a 5% tariff hike on all US imports. The current measures announced still fall within this range, so there is no immediate reason to adjust our projections for growth and inflation. However, as Trump’s tariffs continue to accumulate, and as other countries retaliate, the risk of a more significant stagflationary shock has increased. A plausible scenario for such a backdrop would be if Trump follows through on his threat of an additional 25% tariff on other selected goods, such as pharmaceuticals and chips, or, even worse (but less likely), a 25% universal tariff.

Fittingly, the US reported another astonishingly high trade deficit number for February. The deficit in goods amounted to USD 147.9 billion, on top of January’s USD 155 billion deficit. This averages to a whopping USD 1.8 trillion annualized, over 6% of US GDP. The widening deficit reflects efforts by US companies to secure goods and materials in advance of higher tariffs. In fact, much of the widening in the deficit since December 2024 can be traced to imports of gold bars, predominantly from Switzerland and the UK. The (advanced) February data suggests strong imports of industrial supplies – which not only includes gold, but also steel and aluminum – were still a key driver. But even if industrial supplies are excluded, the trade deficit would be at record levels.

Obviously, this front-running of tariffs caused quite a scare earlier in March when the Atlanta Fed’s GDPNow model plummeted to -2.8% annualized for 25Q1. This prompted the modelers to introduce a “gold-adjusted” version. After all, given that substantial portions of these industrial metals are likely being invested in inventories, the direct impact on GDP should be relatively neutral. However, even with gold excluded, net exports remain a considerable drag on GDP. The gold-adjusted estimate currently stands at +0.2% q/q annualized, which is not pretty.

Across the border, Banxico cut the policy rate 50bp to 9.00%, in line with our expectations. Notably, in its statement, Banxico said that “looking ahead it could continue calibrating the monetary policy stance and consider adjusting it in similar magnitudes.” As such, we now expect a 50bp cut at the next meeting in May and have added an additional 25bp cut to our forecasts. This brings us to five more cuts in 2025 to a terminal rate of 7.50%. Interestingly, Banxico notes that the risks to its inflation outlook remain skewed to the upside. However, the risk of persistence in underlying core inflation has been downgraded, now ranking below the risks of peso depreciation and tariff uncertainty. So, tariffs are leading to rate cuts.

It is worth noting that on Wednesday, the Bank of Canada also revealed in its deliberations that it would have maintained its policy rate at 3.00% instead of cutting it to 2.75%, if not for tariff uncertainty and the perceived need to alleviate concerns among consumers and businesses as the trade war impacts the economy. So here too: tariffs -> rate cuts. Of course, an extra cut here or there doesn’t address the bigger problem. Canada’s caretaker PM Mark Carney, who faces a federal election next month and has flipped the polling landscape by pushing back against Trump, has just said: “The old relationship we had with the US –based on deepening integration of our economies and tight security and military cooperation– is over.” That said, Canada hasn’t retaliated on the auto tariffs yet, as the US says if Canada joins up with the EU, both will see far higher tariffs.