<\/p>\n
Stagflationary effects will hit the U.S. hardest, Canada and Mexico at risk too.<\/p>\n
The U.S. economy stands to suffer the most in terms of weaker growth and higher inflation from its trade war, with Canada and Mexico next in line to face the threat of stagflation, according to a new paper from the Bank for International Settlements (BIS).<\/p>\n
In a new bulletin, a handful of economists at the BIS examine the impacts of rising trade protectionism, noting that, while the global economy has so far proven relatively resilient in the face of higher U.S. tariffs, they are expected to hamper global growth.<\/p>\n
In the first half, the economy was bolstered by a \u201cfront-loading of trade,\u201d the U.S. backing off many of its initial tariff threats and relatively easy financial conditions, the paper said.<\/p>\n
However, as higher tariffs persist, their effects are expected to feed through to the global economy, lowering economic growth and stoking inflation.<\/p>\n
While some countries have reached bilateral trade deals, \u201caverage U.S. tariffs are likely to settle at levels unprecedented in the modern era,\u201d the paper said \u2014 which will act as a drag on the global economy.<\/p>\n
Already, there are signs of the negative effects of higher tariffs, it noted.<\/p>\n
\u201cThe increased trade costs are starting to affect corporate earnings in some manufacturing sectors,\u201d it said. \u201cRecent U.S. economic data \u2014 such as weaker private spending, persistent inflation and softening labour market performance \u2014 indicate emerging economic weakness.\u201d<\/p>\n
Additionally, ongoing trade policy uncertainty, \u201ccould depress domestic demand and put global growth at risk,\u201d it said.<\/p>\n
Alongside weaker growth, the \u201cinflationary effects of tariffs could also be significant,\u201d the paper said, although these impacts will likely vary, since the tariffs have mostly been imposed unilaterally by the U.S., which is facing, \u201chigher import prices that are likely to increase price pressures,\u201d as a result, it said.<\/p>\n
In other markets, the inflationary impacts are less certain.<\/p>\n
\u201cOn the one hand, lower export demand, trade diversion and currency appreciation can reduce inflation. On the other hand, if tariffs disrupt supply chains, higher inflation could materialize globally,\u201d it said.<\/p>\n
And with a recent episode of global inflation still fresh in the memory of businesses and households, \u201cinflation expectations could be less well anchored in this event,\u201d the paper said.<\/p>\n
Indeed, the countries that impose tariffs face a \u201cstagflationary shock,\u201d the paper said, as \u201ctariffs raise import prices, thereby depressing real income and demand\u201d \u2014 while the countries that are hit with tariffs face lower export demand that leads to lower growth and inflation.<\/p>\n
According to the paper, various economic models project, \u201clower output growth across the board,\u201d due to tariffs \u2014 with the U.S. \u201cthe most affected economy due to tariffs being imposed on a wide range of trading partners.\u201d<\/p>\n
Other major economies, including Europe and China, are generally projected to feel smaller impacts, although it also depends on the ultimate tariff levels and any retaliation.<\/p>\n
In any scenario, the U.S. economy, \u201cremains the most affected in terms of both growth and inflation,\u201d the report said.<\/p>\n
While in scenarios that involve the highest tariffs and retaliation, \u201cCanada and Mexico would face the strongest stagflationary effects, after the U.S.,\u201d it said.<\/p>\n
Alongside the risk of retaliation exacerbating the impact of higher tariffs, there\u2019s also a risk that the financial conditions that have buffered the immediate impact of higher tariffs don\u2019t last, the paper cautioned.<\/p>\n
\u201cInvestor risk appetite could buckle as the effects of tariffs grow more apparent, leading to tighter financial conditions,\u201d it said. \u201cStretched valuations and existing financial vulnerabilities could aggravate market corrections, particularly if lenders retrench and financial accelerator effects kick in.\u201d<\/p>\n
Additionally, an ongoing depreciation of the U.S. dollar carries risks too, the paper said.<\/p>\n
\u201cThe shock-absorbing function of exchange rates could become impaired, possibly exacerbating the inflationary impact in the U.S. and disinflationary effects elsewhere,\u201d it said \u2014 while also potentially undermining the U.S. dollar\u2019s status as the global safe haven currency.<\/p>\n
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