Assessing the effect of tariffs

First the good news. US tariffs are settling at lower levels than had seemed likely in early April. Negotiations with trading partners, including the EU, Japan and the UK, have resulted in the average US tariff on goods imports dropping from the 28% rate president Donald Trump announced on 2 April to 18.6% today.

The bad news is that this is a sizeable shock to the global trading system, with far higher tariff rates than economists had expected at the start of the year. US tariffs have risen sevenfold since January to the highest level since the 1930s.

Tariffs tend to raise inflation, squeeze consumer incomes and depress growth. Yet the US has defied the direst economic predictions. Inflation is under control, the economy is growing, the equity market is booming and federal revenues from tariffs have surged.

Could the US be winning on tariffs? This week’s briefing assesses the evidence.

Tariffs have not caused a spike in inflation. At 2.7% in June, inflation was below levels seen over most of the last year. Forecasts for US inflation next year haven’t changed much since January – not what one might have expected given how far US tariffs have risen.

Prospects for US growth have certainly weakened since April, with economists paring back their forecasts for GDP growth. But talk of recession, which was widespread in spring, has dried up, and in the last couple of months economists have nudged up their US growth forecasts. The general expectation is that US growth will outpace every other G7 economy this year and next.

Investors have flocked into US stocks since Mr Trump announced a 90-day pause in tariffs on 9 April. US equities have outperformed other major markets, and are up 26%, with the S&P 500 hitting an all-time high.

US government revenues from tariffs have surged, fulfilling what Mr Trump sees as one of the main aims of the policy. The Budget Lab at Yale, an academic think tank, estimates that higher tariffs will raise $2.1tn between 2025 and 2034, enough to finance about 60% of the cost of the administration’s tax cutting ‘One Big Beautiful Bill’ which passed into law last month.

Retaliation against US tariffs has been limited and the world has not descended into a trade war. Several major trading partners have accepted US tariffs, some grudgingly. German chancellor Friedrich Merz said the US-EU trade deal would "substantially damage" his nation's finances, while French prime minister Francois Bayrou said it was tantamount to "submission".

Some trading partners have also agreed to increase investment in the US and their purchases of US products. The EU has undertaken to buy $750bn worth of energy products from the US over the next three years, up from a current rate of $75bn a year, and to invest $600bn including in US defence equipment. Saudi Arabia, the UAE and Qatar have pledged significant new investments.

An array of companies – including Apple, Meta, Softbank and the world’s largest semiconductor manufacturer TSMC – have announced new investments in the US in recent months. The Trump administration sees this as furthering its aim of bringing manufacturing back to the US.

Yet it would be premature to declare that tariffs have been a success for the US economy.

Although tariff rates have risen, their full effect has yet to be felt. Decisions by companies on margins and stock levels have significantly softened the initial impact of tariffs on the US economy.

Goldman Sachs estimates that US businesses have absorbed around three-fifths of the extra cost duties imposed so far. Foreign suppliers are also bearing some of the load. Given the chopping and changes in tariff policy since 2 April, with rate rises, cuts and pauses, businesses may have been hoping for a reprieve and, therefore, prepared to absorb some of the cost. For US companies the prospect of lower business taxes, courtesy of the ‘One Big Beautiful Bill’, has probably helped. In any case squeezing margins is no free lunch for the economy since they weigh on corporate spending, investment and risk appetite.

The other mitigating factor is the role of stocks, or inventories. US companies stepped up imports and built up stocks ahead of Mr Trump’s ‘liberation day’ announcement. Those tariff-free goods have been feeding into the market and have cushioned the impact of tariffs on consumers.

Stockpiling, the 90-day pause in the application of tariffs and a squeeze on corporate margins mean that the actual tariff rate paid by US consumers has lagged well behind the headline, average rate, which now stands at 18.6%. Tariff-free stocks will run out and there are limits to how far margins can be squeezed. In the coming months, the effect of higher tariffs is likely to become increasingly apparent to US consumers and businesses and in the inflation numbers. Tariffs are already showing up in the price of some items including car parts and furniture. Economists expect headline inflation to drift up from 2.7% in June to 3.4% by December.

US activity may not have collapsed, but prospects have weakened since April’s tariff announcement. The US is likely to grow at about half last year’s rate in 2025. The jobs market is cooling, and US activity is distinctly lopsided. Deloitte’s chief economist in the US, Ira Kalish, points out that in the first half of 2025 technology investment, mostly related to AI, accounted for 59% of US growth. Enthusiasm about AI has also powered US equities higher since April’s low, with the big tech stocks far outpacing the rest of the market.

The effect of hiking tariffs to 18.6% is yet to fully feed through to US businesses and consumers. A more complete picture will emerge in the coming months. But it’s hard to see why the effect of such large tariff increases would deviate from the past pattern of increasing prices, reducing consumer choice and weakening growth.