Eurozone: Euro will cushion, but not offset, the tariff impact

Despite the recent appreciation, our forecast still sees a weaker euro versus the US dollar compared to our pre-US election baseline. We think this will partially mitigate the adverse growth impact of tariffs. But extra-Eurozone exports have become less sensitive to a weaker euro over time, so currency depreciation cannot be relied on to offset the adverse impact of price shocks on Eurozone exports.

Eliminating the exchange rate risk within the currency union incentivises companies to domesticate value chains, but increased integration into global value chains fosters countries’ mutual dependence and makes currency depreciation less effective at boosting exports.

Higher input prices because of rising global protectionism will make it harder for firms to take advantage of a relatively weaker euro by increasing production. But this doesn’t mean it won’t support exports. The rest of the world counts for a larger share of total Eurozone exports than in the early 2000s.

An increased global middle class means a weaker currency can help exports grow, but evolving global consumer preferences for goods higher on the value chain could weaken this channel.

A weak euro supporting competitiveness won’t fully offset the current productivity malaise and a potential disorderly global trade realignment. ‘Slowbalisation’, trade fragmentation, and a steady euro appreciation in line with fundamentals will incentivise Eurozone firms to strengthen regional value chains and eliminate exchange rate risk.