The risk of an inflation surprise

Higher trade tariffs could push inflation higher

Several economic studies suggest that the current trade war between the US and China could lead to higher inflation.

Reports conducted by independent institutions, such as the National Bureau of Economic Research or regional Federal Banks in the US, suggest that imposing a 25% tariff on all Chinese imports would likely increase US inflation by 50 basis points (bps) to 100 bps in the short term. This conclusion is based on analysis conducted after the first wave of tariffs in 2018, which impacted products such as solar panels, washing machines and steel.

When tariffs are imposed on finished goods, consumer prices for this product will likely increase to compensate, at least partly, for the higher cost of import. For example, in January 2018, the US imposed 20% tariffs on the first 1.2m washing machines imported, with tariffs on all additional imported washing machines being imposed at 50%. In the ensuing months, the US laundry equipment inflation jumped by around 15% as companies passed on some of the costs of these tariffs to the consumer.

Consumers pay the price of a trade war

Similarly in 2018 steel prices rose, giving some insights into the impact on inflation from increased import duty on intermediary goods. In this case, companies which buy steel as an intermediary good in their production process had to choose between either increasing the cost of their final products, passing it to their consumers, or lower their margins and absorb it themselves. It seems that a majority of the extra costs were passed on to the consumers.

The 2018 tariff increases also shows that Chinese companies were reluctant to slash margins to remain competitive and instead took the risks of losing market share. And while Chinese imports to the US fell modestly initially, they did not collapse until early 2019. This is because domestic producers also increased their prices. For example, with the tariff on steel increasing the cost of steel coming from abroad, US steel producers could also increase their prices.

As both price and cost increased proportionally, margins remained relatively healthy and firms remained competitive. In such a scenario, the impact of higher prices falls on consumers.

We recommend looking for companies with a strong brand, pricing powers and product demand not dramatically affected by a price increase. We also see opportunities in US inflation-linked bonds.

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

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