SUMMARY
The US is Europe’s leading trading partner. This raises risks of near-term disruption, even as defense spending may boost European growth further out.
KEY TAKEAWAYS:
The EU could retaliate against US tariffs, negotiate, and strike new deals elsewhere
Sector-specific tariffs could yet target certain European industries
Longer-term, increased defense spending could boost European growth
European EPS forecasts may come down near-term; we are neutral on regional equities
How much of a threat to Europe do proposed US tariffs represent? This is a pressing question for the European Union, Switzerland and the UK, which face potential levies on their exports to the US of 20%, 32% and 10% respectively.
The US is a major trading partner for all three powers. The EU, for example, accounts for 18.5% of US imports, its largest single relationship in goods. We believe that the US’s decision to impose a hefty tariff on an important geopolitical ally may erode trust, with negative implications for trade and cross-border investment.
Trade uncertainty could also have more immediate fallout, of course. We see a danger that importing and exporting businesses in the EU curtail investment and hiring decisions amid the current turmoil. If so, this would hinder regional growth.
Another issue for exporters across the region is Chinese competition. Facing triple-digit US tariffs, China may seek to redirect its goods to other global markets, slashing prices to win business. This could intensify competitive pressure on certain European firms.
While the timing is unclear, the US has said it may yet impose sector-specific tariffs on the rest of the world. European sectors that generate substantial revenues from the US may find themselves targeted.
Healthcare companies from publicly-traded companies in the EU, Switzerland and the UK could be especially exposed – figure 1. Communication services and industrials also figure high on the list.
Figure 1. European listed companies’ US revenue exposure
Sources: MSCI, FactSet, Bloomberg and Citi Global Wealth Investments, as of April 4, 2025. Past performance is no guarantee of future returns.
How might Europe respond to US tariffs?
The European Commission, which leads trade on behalf of the EU, appears to believe that the US’s global tariff strategy will likely encounter difficulties and that time is on Europe’s side.
As the largest market in the world, the EU may have more opportunities to negotiate new economic and/or trade agreements with other regions. The threshold to making new EU trade agreements is rather low. Such deals would only require the approval of 55% of member states – 15 out of the 27 – accounting for 65% of the total EU population.
We also think that there is room for compromise with the US. The US administration has published a long list of grievances spanning tariff and non-tariff barriers to trade. The latter include many rules, procedures and standards that impede US access to EU markets. The EU may show some flexibility here, albeit without giving way on some of its most cherished principles.
Still, there are strong differences of opinions within the EU about when and how to proceed if negotiations fail. Member states that are highly reliant on their trade in goods with the US such as Germany and Italy might lobby the European Commission t o reduce tariffs on some US goods in exchange for a lower average reciprocal tariff.
Any large-scale retaliation from the EU will most likely target services. The US is running a large surplus on services with the EU. Regulatory penalties against big tech companies offer a likely target, in our view.
Europe’s brightening long-term outlook
Europe’s longer-term prospects received a boost March, prior to the tariff announcements. Germany amended its constitution to enable a very large boost in infrastructure and defense expenditure. Other regional governments are also planning to up their defense spending.
So, how much might all this add to Eurozone GDP? The planned outlays are likely to cost more to finance following recent rises in European borrowing costs. (We assume that spending will be covered largely by borrowing rather than with tax rises or cuts to spending elsewhere.) Our rough estimate is for GDP growth to be 0.2-0.3 percentage point (pp) higher in 2025, 0.4-0.5pp higher in 2026, and average around 0.75pp higher in 2027-28.
Earnings forecast cuts coming meanwhile
Tariff and trade uncertainty means that first quarterly consensus estimates for earnings-per-share (EPS) growth in Europe appear overly optimistic. We have already seen early signs of downward revisions to European EPS forecasts, with a narrowing gap between US and European EPS revisions.
That said, we see further downside ahead of the earnings season. We suspect that the full extent of the tariff related pressures may not be fully reflected in current estimates and therefore we expect analysts will likely cut their 2025 and 2026 earnings outlook.
Not all companies will be reporting, but even those that do not may still choose to offer updates, reassurances or guidance to reduce uncertainty.
Our positioning on Europe
Following a sharp selloff and then partial recovery, Europe’s price-earnings ratio stood at 14.1, slightly below the 15-year average of 15.1. Despite this potentially more attractive valuation, we remain neutral on European equities for now.
However, over the medium- to longer-term time horizon, the prospect for higher potential growth and increased issuance of debt should be important factors that could lead investors to consider allocating more to Europe.
