President Donald Trump’s threat to impose a 50% tariff on goods from the European Union from June 1 has sharpened fears of a renewed transatlantic trade war, though many analysts see the move as a negotiating tactic rather than a concrete policy shift, say analysts at Capital Economics in a note published on May 23.

The announcement, made on Trump’s social media platform earlier the same day, comes amid faltering talks between Washington and Brussels. Media reports suggest US officials are frustrated by the EU’s insistence on mutual tariff reductions, with little progress on contentious issues such as digital taxation.

While the language of “recommending” tariffs and noting that negotiations are “going nowhere” indicates posturing, the potential economic fallout of a follow-through would be significant, the analysts say.

“If it were implemented, it could result in a substantial fall in GDP in Germany and potentially even higher in Ireland if pharmaceuticals were included,” analysts at Capital Economics said.

Using its Tariff Impact Model, Capital Economics estimates that a blanket 50% tariff would reduce German GDP by around 1.7% after three years, compared to a scenario without the tariff. The predicted impacts are smaller but still notable for Italy (1.25%), France (0.75%) and Spain (0.5%). Ireland, whose economy is heavily reliant on pharmaceutical exports, could suffer a 4% decline if the sector is affected.

“These estimates assume no second-round and uncertainty effects – which could be substantial with such a huge tariff,” Capital Economics noted. “Indeed, the effect of tariffs is probably non-linear given that small frictions can more easily be absorbed by producers and consumers.”

The analysis also assumes no retaliatory action from Brussels, which in reality would be expected to respond. European policymakers might also intervene with fiscal or even monetary support to mitigate economic damage.

Despite the threat, Capital Economics maintains its base case that “tariffs on the EU will ultimately settle around 10%”. However, it cautioned that “this underlines that there are risks and that the road to an agreement could be rocky.

Fiscal stimulus won’t boost German growth

Capital Economic’s Franziska Palmas separately wrote a pessimistic report, saying that German’s plans to borrow heavily and spend on defence and infrastructure will not be the panacea to its economic woes that some expect.

Germany’s shift to looser fiscal policy, including a significant increase in defence and infrastructure spending, will lift growth temporarily, but deeper structural weaknesses will leave Europe’s largest economy struggling in the long term, according to Palmas, Senior Europe Economist at Capital Economics.

“We expect Germany’s GDP to grow by 1% per year in 2026 and 2027,” Palmas said, pointing to a fiscal boost worth around 0.7% of GDP annually, largely from higher public spending. However, she warned that “growth will then slow to just 0.5% per year from 2028 to 2030” due to a range of entrenched issues, including an ageing population, weak productivity gains, and ongoing deindustrialisation.

The temporary boost will be supported by tax incentives for private investment, subsidies for electric vehicles, and easing pressures from US tariffs. Yet Palmas noted that “most of the fiscal stimulus will go towards areas that do not significantly enhance productivity.” Defence spending, for instance, is expected to prioritise personnel and equipment over research and development, while infrastructure investment will mainly address maintenance backlogs rather than enabling technological transformation.

Germany’s labour market problems are particularly bad. “The working-age population will shrink rapidly, and government efforts to raise participation and attract skilled immigration will only partly offset this,” she said. Palmas estimated that net immigration of 270,000 annually would fall far short of the 800,000 required to fully compensate for demographic decline.

She also highlighted continued deindustrialisation as a drag on both employment and productivity. “German industrial output has been falling since 2017, and we expect it to keep declining, especially in autos and energy-intensive sectors,” she said. German’s heavy industry has been particularly hard hit by rising energy costs since the crisis in 2022, which remain double their pre-war in Ukraine rate. The economic malaise has since spread to the automotive sector where many of the leading carmakers are loss-making and have been forced to shutter German-based factories for the first time.

“Factors including weak domestic and foreign demand, high energy costs, and increased competition from China are expected to weigh heavily,” says Palmas.

This economic stagnation is likely to have broader consequences. Palmas warned that “support for populist parties, particularly the AfD, could rise further,” especially in regions hit hard by industrial decline. She added that a stronger showing by the far-right in the 2029 election could “lead to a paralysed government unable to implement structural reforms.” According to the latest polls, AfD has seen its popularity continue to rise. After coming second in the recent parliamentary elections with 20%, the latest polls indicate its approval rating is now level or even slightly ahead with the ruling CDU party, led by German Chancellor Friedrich Merz.

Germany’s fiscal position will also come under pressure. Capital Economics projects that the country’s debt-to-GDP ratio will rise from 62% in 2024 to 74% by 2030, as higher public spending combines with weak growth and rising age-related costs. “This may force future governments to trim welfare benefits or increase social security contributions,” Palmas said.

Despite its domestic headwinds, Germany’s influence within the European Union is unlikely to fade in the near term. “Germany will remain the largest economy and the biggest net contributor to the EU budget,” said Palmas. However, she expects Berlin to remain reluctant to support closer fiscal union, particularly as a weakened fiscal stance could heighten domestic opposition.

More broadly, Germany’s sluggish growth will weigh on the EU’s global standing. “We don’t expect the EU to emerge as a third global economic bloc alongside the US and China, and Germany’s economic performance is a key reason why,” Palmas concluded.