The road to recovery in the Eurozone is bumpy, and Citigroup warns that the impact of tariffs is more severe than expected

Citigroup warns of a short-term economic slowdown in the Eurozone, with the impact of tariffs potentially being underestimated.

According to news from the Chasing Wind Trading Desk, Citigroup analyst Giada Giani pointed out in a recent report that the impact of tariff shocks on the Eurozone economy may be more severe than the market generally expects.

Giani noted that so far, the "export rush" effect triggered by tariff policies has had a positive effect on Eurozone growth, with GDP expected to increase by 0.5 percentage points in the first half of the year. However, this effect is expected to reverse in the second half, causing a similar level of drag, with GDP growth projected to slow to nearly 0% over the next three quarters.

According to the assumptions in the report, under a baseline scenario of 20% tariffs, Eurozone growth could cumulatively decrease by 1 percentage point over six quarters.

Citigroup also slightly lowered its inflation forecast for the Eurozone in 2026 to 1.5%, down from an average of 2.0% in 2025, and expects it to be slightly below the 2% target level in 2027.

Weakening "export rush" effect, negative impact of tariffs gradually emerging

The report shows that U.S. tariffs have so far stimulated an "export rush" in the Eurozone, boosting local GDP by about 0.5 percentage points through inventory accumulation in the first half of the year. Specifically, the surge in exports in the first quarter contributed 0.3 percentage points to net exports, but signs of normalization have appeared in the second quarter.

Citigroup expects that starting from the third quarter, this effect will turn into a drag.

The rebound in manufacturing is not based on fundamentals but is driven by short-term inventory cycles.

Data from the report shows that after a significant increase in exports in the first quarter, normalization has begun. The month-on-month growth rates of industrial production and goods exports both declined in May, indicating that the previous abnormal growth is fading.

In Citigroup's baseline assumption, by the tariff deadline of August 1, if the U.S. imposes a 20% tariff on the Eurozone, it will reduce Eurozone growth by 1 percentage point over six quarters; if the rate rises to 30%, the Eurozone economy could fall into mild recession.

Weak exports threaten investment outlook

Citigroup's analysis shows that the performance of exports affects Eurozone economic growth not only through net exports but also amplifies the impact through profits and investment channels.

The bank's corporate investment model for the four major economies in the Eurozone indicates that for every 1 percentage point change in export growth, corporate investment will change in the same direction by 0.7 percentage points in the following two quarters.

The report points out that this "accelerator" effect explains the weak investment resulting from poor export performance in 2023-2024.

Although investment performance was strong in the first quarter, with a quarter-on-quarter growth of 1%, the weak export outlook, low capacity utilization, and continued low corporate confidence are expected to negatively impact investment decisions and hiring in the coming months.

Domestic demand struggles to fully offset external shocks

Private consumption in the Eurozone has been recovering since the second half of 2024. Citigroup expects that real income growth and high savings rates will continue to support consumer spending in 2025-2026, providing some offset to the negative impact of tariffs.

In addition, construction activity and the real estate market, being the most sensitive sectors to interest rates, are also expected to continue recovering and alleviate some external drag. The continued improvement in mortgage demand and strong house price growth provide further momentum for residential investment.

However, the report believes that this is unlikely to fully offset the tariff impact.

The report shows that recently, consumer confidence has declined, and corporate hiring intentions have decreased, which are concerning factors; at the same time, the high savings rate still reflects the increased attractiveness of financial investments relative to consumption in a high-interest-rate environment.

Citigroup expects that overall domestic demand will not be sufficient to avoid a slowdown in growth, with GDP quarter-on-quarter growth close to 0% in the next three quarters, mainly dragged down by weak exports and investment.