Trade deals or trade wars? Germany’s insoluble budget equation and tariffs diminishing carmakers’ reshoring prospects

The 15% tariff to be applied to most EU goods is slightly lower than the 20% announced on "Liberation Day" – or the 30-50% threatened since then – but still much higher than the initial conditions. As part of the deal, the EU agreed to purchase energy and military equipment from the US and to invest in the US. This seems quite far from the strategic autonomy rhetoric of the past few months. Economically, the deal aligns largely with our previous expectations, implying EU export losses of around EUR 50bn (0.3% of GDP) compared to 2024 levels. Market reactions suggest the agreement is more favorable to the US than expected, with the euro losing 1.7% initially. Meanwhile, Q2 GDP data on both sides of the Atlantic indicate that the trade war is already starting to bite. The frontloading of exports to the US reversed in Q2, with net trade (lower imports) supporting US growth (up from -0.1% in Q1 to +0.7% q/q in Q2, non-annualized) but dragging on the Eurozone (down from +0.6% to +0.1% in Q2). Looking at domestic demand, US growth looks much weaker with only +0.3% q/q, similar to the Eurozone, amid low consumer and business confidence. Going forward, we expect US inflation to rise to close to 4% by year-end and growth to slow as the latest tariff decisions will push the US global tariff rate to 16% by 7 August, from 13% currently. Meanwhile, Eurozone inflation stayed put at 2.0% y/y in July, which combined with the ECB’s hawkish tone last week would mean the ECB may not be able to deliver two additional rate cuts this year as previously expected.

Germany’s 2026 budget has public investment rising to EUR127bn and defense spending reaching EUR82bn. Rising core expenditures mask the sharp decline in federal spending, not seen since the 1990s. As a result, net borrowing will rise from EUR81.8bn in 2025 to EUR89.9bn in 2026, with accumulated net borrowing across the legislative period 2025 to 2029 approaching EUR807bn. But much of this is kept outside the core budget, concealing fiscal constraints. Discretionary spending could fall from 22% in 2026 to below 5% by 2035, pressured by social benefits and interest payments, which are projected to double by 2029. Future-oriented investments (education, infrastructure, digitalization, climate) are financed by one-third through special funds in 2025, with the share rising to 56% in 2026 and two-thirds by the end of the legislative period. As reliance on these temporary special funds grows, the risk increases that, once they expire, future-oriented investments will face cuts or require higher debt, threatening long-term growth. To ensure fiscal sustainability and growth, structural reforms alongside a strategic budget reset are essential.

A 15% tariff could be a Pyrrhic victory for the US. It would give European and Japanese carmakers an advantage over their Mexican and Canadian counterparts, who would face a 25% tariff on cars produced for the US market. Yet, we do not expect a wave of reshoring, especially amid lower policy support for electric vehicles and weaker cash-generation capabilities. We find that US domestic production capacities have risen +9% this year, increasing their share of global automobile production by a noticeable +1.5%. Ultimately, automakers are battling bigger challenges, including decreasing demand in developed economies, higher competition from Chinese brands and less fiscal support for EVs in Europe (with more stringent carbon regulation) and the US. In 2025, corporate margins are expected in the low-to-mid single digits, forcing companies to focus on short-term profitability and cash-flow generation, rather than reshoring.