Shot by both sides, the Eurozone faces recession threat

The U.S. and eurozone economies parted ways in 2022, with the former growing rapidly while the latter faltered under the burden of sharply higher energy costs and the blow to confidence from the largest military conflict to hit Europe in eight decades.

To the surprise of many economists, the eurozone has avoided a recession, if only just. Indeed, the only quarter of slight contraction came at the end of 2022, when high energy bills limited the ability of many households to spend on other goods and services.

While its own consumers were tightening their belts, European businesses could at least sell to other parts of the global economy that had been less wounded by the war, including the U.S. But the announcement Wednesday of a 20% U.S. tariff on imports from the European Union may prove to be one blow too many.

“The direct impact of lower exports will drag growth down but even more damaging could be the broader shock to confidence," said Gaurav Ganguly, an economist at Moody’s Analytics. “If negotiations fail to yield concessions and these tariffs remain in place, the eurozone will slip into recession this year."

The eurozone economy may yet escape a sustained contraction. Estimates of the impact of tariffs vary widely, and some key sectors have been exempted for now, such as pharmaceuticals.

In March, the ECB’s economists forecast that the eurozone economy was set to grow by 0.9% this year and 1.2% in 2026. Their estimates said a 25% tariff on eurozone exports to the U.S. would lower growth by 0.3 percentage points in the first year. Depending on the timing of maximum impact, eurozone output could decline in a quarter, and perhaps more than one, but the economy shouldn’t see a lengthy contraction.

One difficulty in estimating the force of the blow is judging the impact on confidence of a major shift in the global economic order that isn’t of Europe’s choosing. HSBC estimates that a 10% tariff could knock a third of a percentage point off eurozone growth, but the impact could be larger.

“A collapse in confidence could easily trigger a much bigger downturn," economists at the bank wrote in a note to clients.

As with the war in Ukraine, a trade war with its closest ally poses fundamental and disquieting questions about the kind of world Europeans inhabit.

“Institutions, norms and alliances that seemed timeless can suddenly be remade," European Central Bank President Christine Lagarde said in a speech Wednesday in which she outlined Europe’s options in an “inverted world."

There have also been some recent changes to economic policy that may soften the blow. Eurozone governments have pledged to increase spending on defense to counter a potential threat from Russia without the full support of the U.S. Germany has additionally announced a big drive to repair frayed infrastructure.

In combination, those measures are likely to shift the sources of growth toward domestic demand, and away from exports. But they will take time to have an impact, and the new tariffs take effect later this month.

European governments will likely do what they can to help out sectors that have been hit particularly hard by the tariffs, while the ECB may also have a part to play. An account of the March meeting released Thursday showed some policymakers were considering the possibility of a pause in their series of rate cuts this month.

But the new tariffs make it more likely that investors will get the rate cut that they expect, with perhaps more to come.

“Higher-than-expected tariff rates tip the balance in support of looser monetary policy," said Andrew Kenningham, an economist at Capital Economics.

Write to Paul Hannon at paul.hannon@wsj.com