What might a Trump presidency mean for the European economy?

As markets have raised bets on a Donald Trump victory in the presidential election in recent weeks, Goldman Sachs economists say another term for the former US leader could have “profound implications” for the eurozone economy.

“Our base case estimates are for a substantial decline in GDP of about 1% with a modest rise in inflation of about 0.1 percentage point,” Goldman Sachs’ Gary Stein and James Moberly said in a note published Friday before Saturday’s assassination attempt.

“A Trump re-election would therefore pose a significant risk to our constructive outlook for euro area growth.”

They explained that uncertainty over trade policy, additional defence and security pressures, and the spillover effects of US domestic policies, for example on taxes, would affect Europe.

Trump was shot and wounded Saturday during an assassination attempt at a rally in Pennsylvania. The shooting left one attendee and the gunman dead, and two other attendees remain in critical but stable condition.

Some analysts have suggested that these events could boost Trump's chances of retaking the White House in the US elections later this year, and some asset prices were already rising on Monday as markets priced in that possibility.

Even before Saturday, odds of a second Trump presidency had been rising after President Joe Biden’s poor performance in a presidential debate a few weeks ago. Goldman Sachs said in a note on Friday that betting markets were pricing in about a 60% chance of a Trump win in November, with some reports over the weekend that that number had risen again.

Analysts Stein and Moberly said Trump's trade policy, and the uncertainty surrounding it, could be one factor weighing on Europe's economy, just as it did during his last presidency.

Trade tensions between the US administration and the European Union escalated during Trump’s last term. The US imposed tariffs on European steel and aluminium, prompting the EU to retaliate with tariffs on US goods. There have been months of concerns about whether other sectors such as autos would see higher tariffs, which has rattled market sentiment.

“Trump has pledged to impose a 10% blanket tariff on all US imports (including from Europe), which is likely to lead to a sharp increase in trade policy uncertainty, as happened in 2018-19,” the bank said in a research note.

Economists have explained that this type of uncertainty has historically had a significant and persistent impact on economic activity in the euro area. In 2018 and 2019, uncertainty over trade policy reduced industrial production in the euro area by about 2%, they estimate.

Some countries, such as Germany, are expected to be more affected because they rely more on industrial production, according to Stein and Moberly.

Trade tensions could also hurt eurozone GDP, and while uncertainty over trade policy could push prices lower, higher tariffs could push them higher again, economists say.

Trump is also expected to reduce or cut off U.S. aid to Ukraine, and has indicated that he will not provide military assistance to NATO countries that do not meet the 2% defense spending requirement.

Goldman Sachs said that meeting the 2% condition and replacing at least part of the US financial support for Ukraine could affect the European economy.

“European countries may therefore be asked to fund an additional 0.5% of GDP in defence spending annually during a second Trump term,” the research note said, adding that growth from additional military spending is set to be modest.

Stein and Moberly explained that uncertainty and geopolitical risks could also arise as a result of Trump's defense policy toward Europe and his position on NATO, especially if that raises questions about the extent of the United States' commitment to the military alliance.

The third way Trump's policies could affect the eurozone economy is through US domestic plans, such as tax cuts and reduced regulations.

“The shifts in US macro policy during Trump’s first term have had a significant impact on Europe through stronger US demand and tighter US financial conditions,” Goldman Sachs economists said.

Expected tax cuts in the U.S. could boost economic activity in Europe — but with other expected market shifts, the overall impact is likely to be limited, according to Stehen and Moberly.

“However, the net fiscal impact is likely to be muted, as we expect the impact of higher long-term interest rates to be offset by a marked weakening in interest rates. euro“This is in line with the moves that followed the elections in November 2016,” they said.