The global fight against inflation appeared to be over. Most of the world’s top central banks have been cutting interest rates in 2024 as price rises have approached their target – typically 2%.
It brought a sigh of relief from many chief financial officers. While many companies were able to pass on the cost of higher inputs to customers – or even expand margins – rapid inflation also eroded consumer spending power and triggered higher wage demands. A return to price stability was welcomed by most.
‘Some businesses may have to be nimble in adjusting supply chains’
But this sense of relief may prove premature. The latest releases for both the US and eurozone point to a renewed acceleration in inflation, albeit a modest one. Such disappointments, however, may be just a taste of things to come. Donald Trump’s win in the US presidential election has raised the possibility that inflation could make a real comeback.
Tariffs and more
All of the president-elect’s flagship policies – higher trade tariffs, tax cuts and tighter immigration controls – have the potential to drive price rises. Most ominously, Trump recently restated his intention to impose sweeping tariffs on key trade partners, starting with a 25% import tax on goods from Canada and Mexico along with an extra 10% levy on Chinese goods. The three countries account for 43% of US goods imports.
Europe could be next. As recently as October, Trump said Europe will ‘have to pay a big price’ for what he describes as unfair trade practices. A full-blown trade war could help push inflation higher in the eurozone, despite the recent weakness of the bloc’s economic growth.
A full implementation of Trump’s policies would likely drive prices up
Inflation potential
So how great is the threat from inflation and what might this mean for companies?
Most economists agree that the potential for elevated inflation is most obvious in the US. A full implementation of Trump’s policies would likely have a pronounced effect on prices. Starting with tariffs, Goldman Sachs has estimated that the increases proposed by Trump on Canada, Mexico and China alone would boost core US inflation (excluding food and energy prices) by almost 1 percentage point.
Second, Trump’s proposals for immigration curbs, and even large-scale deportations of illegal workers, could push up wages, and therefore prices. Finally, Trump’s promise to extend expiring tax cuts from his first term, and add some more to the mix, could provide a US$7.75 trillion boost to the economy over the coming decade, which would accelerate economic growth but also inflation.
Altogether, this combination could push inflation back up to between 6% and 9.3% by 2026, according to an analysis by the Peterson Institute, rather than the tame 2% that might otherwise be expected.
Trump is expected to be sensitive to the risk of unsettling the US stock market
Optimism
The good news for businesses is that most economists don’t expect such an extreme outcome. The overwhelming majority argue that inflation under Trump will be in the order of tenths of a percentage point higher, rather than full percentage points. This optimism is premised on the expectation that the incoming president will shy away from policies that threaten to revive the multidecade inflation highs of 2022.
Trump will have noted the electoral pummelling incumbent governments took following the last bout of price rises – they include the Democrats in the US, the Conservative Party in the UK and President Emmanuel Macron’s centrist allies in France. Trump is also expected to be sensitive to the risk of unsettling the US stock market, which he views as a barometer of his success.
Finally, while Trump has hinted that he would like a greater role in determining interest rates, the Federal Reserve can be expected to counter any inflationary tendencies. There are considerable institutional safeguards protecting the independence of the Fed, according to Ryan Sweet, head of US research for Oxford Economics. The president can’t fire Fed governors, so barring a wave of resignations he won’t be able to quickly reshape the board. The five rotating regional Fed presidents, who are not picked by US presidents, ‘provide another layer of security’ against politicising the central bank, Sweet points out.
‘Eurozone inflation will likely fall below the ECB’s 2% target’
Modest rise
The bottom line is that both Capital Economics and Oxford Economics expect an inflation rate under Trump only modestly above the Fed’s 2% target. ‘Trump’s policies could require some businesses to be nimble in adjusting supply chains, depending on how tariffs pan out,’ says Andrew Kenningham, at Capital Economics. ‘There could also be a less abundant supply of labour, if immigration rules become stricter.’
Kenningham argues that a renewed surge in inflation remains just a tail risk. ‘Our forecast of around 2.5% inflation for 2025 would not in itself be a problem for most businesses, especially since the slightly higher inflation would be a symptom partly of robust US growth, encouraged by more relaxed fiscal policy.’
Nor does Kenningham expect inflation to spill over into the eurozone. ‘It looks likely that inflation will fall below the European Central Bank’s 2% target, at around 1.5% next year,’ he adds. ‘This is due mostly to weak growth. Germany is facing a range of structural headwinds, including a shrinking age population, unnecessarily tight fiscal policy, still high energy costs relative to the US and intensifying competition from China in its critical auto sector.’
Léo Barincou, a senior economist at Oxford Economics, also sees a subdued price outlook for the region. ‘We are finally seeing signs that demand for labour is softening, based on hiring intentions by companies,’ he says. ‘More modest wage demands should have a cooling effect on inflation.’
A trade war would be part of the broader trend toward deglobalisation
Forceful retaliation
Of course, this benign inflation outlook could change in the event of a full-blown trade war, in which Europe would retaliate forcefully against any tariffs from the US or seek to stem competition from Chinese automakers. Such a response looks unlikely, Kenningham says. ‘The eurozone’s approach last time Trump imposed tariffs was a very measured and calm response, targeted at symbolic US exports like Harley Davidson rather than major export engines. We would expect the same again.’
ECB president Christine Lagarde recently advocated a strategy of negotiation over retaliation, and this has been the broad strategy of the European Commission.
The bottom line is that Trump’s win – supported by a Republican Congress – is likely to mean higher inflation in the US. It also raises risks of an inflationary global trade war. This is part of a broader trend toward deglobalisation that is posing challenges for financial managers and accountants within companies on both sides of the Atlantic.
But a resurgence of the multidecade inflation highs seen in 2022 and 2023 still looks a relatively remote risk rather than an immediate danger.
