With few data releases, the return of U.S.-China trade tensions captured attention. Financial markets were volatile, but largely down as President Trump tweeted over the weekend that an increase to tariffs on Chinese imports would go into effect Friday. These sentiments were reiterated by other high-ranking U.S. trade officials who accused Beijing of reneging on its promises in earlier negotiations. This rhetoric threatened to derail planned high-level talks with Chinese negotiators; however the Chinese delegation only delayed the meetings rather than cancelling them.

The U.S. administration officially implemented the tariff increase from 10% to 25% on approximately $200bn worth of Chinese imports on Friday. Additionally, President Trump has tweeted that he plans to levy the new 25% tariff on a further $325bn worth of Chinese goods “shortly”, a move that would cover virtually all U.S. imports from China. Even as China urged the U.S. to meet them halfway, they announced that countermeasures will be implemented, although specific details have not been revealed.

Despite the new developments, talks continued on Friday as the two sides try to salvage a deal. A sticking point for the U.S., however, is whether China will agree to implement legal changes so as to facilitate the trade deal and to make the details public. China has resisted this push, insisting that it impinges on their national sovereignty.

The new tariffs will result in a more significant drag on growth if they are sustained, impacting not only capital expenditure and consumer spending but also confidence. In a recent note, we estimate that U.S. growth could be lowered by -0.1% to -0.3% with the higher tariff. Growth could fall by as much as -0.6% if the threatened $325bn becomes a reality. The run-up in inventories witnessed in prior months partially reflected preparation by businesses for this possibility, and with additional tariffs to take effect, they are likely to pass on price increases to consumers.

To date, inflationary pressures have been benign. Consumer prices in April rose 0.3% over the previous month and were up 2% year-on-year (Chart 1). However, the threatened escalation in tariffs could see inflationary pressures firm up. We estimate that consumer prices rose by 0.3ppts from tariffs already imposed and could rise by an additional 0.4ppts if the remaining $325bn of Chinese imports are made subject to 25% tariff (see note).

Despite the U.S.’s heavy use of tariffs to rebalance trade flows, their trade deficit edged up in March, reflecting the difficulties inherent in attempting to redirect international trade. Of note, the merchandise trade deficit with China, a special area of interest, has been declining for the past few months, and hit a five year low in March (Chart 2). This development may positively impact ongoing negotiations between the two economic powerhouses. All told, the U.S. and Chinese economies are at an important juncture. Decisions made now are likely to have significant implications for the global economic landscape in the future.

Shernette McLeod, Economist | 416-415-0413