US-China Trade War Fears Already Hurting Growth

A trade war triggered by US tariffs would cause a global recession—and the mere fear of one is already hurting the economy, European Central Bank board member Benoit Coeure said.

Investors have been wondering whether an economic slowdown, aggravated if not caused by global trade tensions, could delay the end of the ECB’s exit from its aggressive monetary stimulus, aimed at boosting inflation in the eurozone, Reuters reported.

Coeure said the prospect of a trade war was not being discussed by the ECB and its effects on inflation would only become visible in the long term. But he added that expectations of escalating tit-for-tat trade actions between the United States and their partners were already hurting borrowers and investors.

“Falls in equity prices in response to the US announcement to impose a tariff on steel and aluminum, and prevailing uncertainty on the scope of any retaliatory measures, have already contributed to tighter financial conditions,” Coeure said at an event in Cernobbio, Italy, on Friday.

Citing an ECB simulation, he said a 10% tariff on all US imports and exports would cause the global economy to shrink by 1% in the first year, with the United States among the worst hit and the eurozone suffering a less severe decline.

With eurozone inflation hovering just below 1.5%, the ECB is widely expected to wind down its €2.55 trillion ($3.14 trillion) bond-buying program this year and raise interest rates in mid-2019. But declines in stocks and weaker economic data, including some surveys of eurozone activity, have got some investors wondering whether Frankfurt will stick to this path.

Coeure said trade wars were not part of the ECB’s policy deliberations and reaffirmed the bank’s message that its policy stance will remain easy. “That is not a discussion that we are having today,” he told CNBC Television when asked whether the ECB would act in anticipation of a trade war.

“There is very broad agreement in the governing council of the ECB that the high degree of accommodation will remain needed, and that is irrespective of a trade war,” he added.

Extremely Disruptive

San Francisco Federal Reserve President John Williams, who will take the reins of the New York Fed in June, said that while trade actions taken so far have not impacted his assessment of economic growth, the prospect of a trade war does keep him up at night.

“So far (the tit-for-tat on tariffs with China) doesn’t change my view of the economy,” Williams said in answer to a question after a speech in Santa Rosa, California. But a trade war could not only hurt economic growth in the US but could also lead to an undesirable rise in inflation, he added. “The global economy is built on trading with each other, and if we were to try to unwind all of that it would be extremely disruptive and very costly, both for the US and the world,” he said.

Uncertainty in Washington

The rapidly escalating trade conflict with China has upended the prevailing economic dynamic of falling unemployment and faster growth, leaving policymakers and investors scrambling to figure out the way forward.

The threat of a trade war loomed over Jerome H. Powell’s inaugural speech as federal reserve chairman on Friday in Chicago, even as he tried to focus attention on the so-called fundamental strength of the American economy.

Financial markets fell Friday morning after President Donald Trump’s latest salvo against China, then tumbled further after Powell indicated that the fed saw no imminent need to adjust its outlook. The Standard & Poor’s 500-stock index ended the day down 2.2%, closing a turbulent week.

And there was uncertainty in Washington, where lawmakers, lobbyists and even White House officials struggled to discern how much of Trump’s move was policy and how much was bluster.

The president acknowledged that the trade friction could take a toll. “I’m not saying there won’t be a little pain,” he said in a radio interview on Friday. “But we’re going to have a much stronger country when we’re finished.”

The fed chief, who took his post in February, said it was “too early to say” what impact the dueling trade measures would have. “We don’t know the extent to which the tariffs will actually come into effect and, if so, how big will that effect be and what will the timing of it be,” Powell said.

The trade tensions complicate what was already a tricky task for the Fed. Hundreds of billions of dollars in tax cuts and spending increases risk fueling inflation, as do wage pressures from a robust labor market.

A trade war could act as a drag on economic growth, forcing the fed to be even more cautious. But tariffs could also raise consumer prices by limiting cheap imports from China and other countries. That could increase the risk that the fed will lift rates too quickly, choking off the recovery.