Tariffs Could Reignite Inflation, UBS Warns

Economists have recently expressed cautious optimism over the containment of inflation. However, the potential reimposition of tariffs could undermine this progress, sparking a resurgence in inflationary pressures.

More Than a One-Time Price Hike

While often perceived as one-off price increases similar to sales taxes, tariffs have a far-reaching impact on inflation. UBS analysts emphasize that tariffs do not merely trigger immediate price hikes but have sustained effects through multiple economic channels.

As taxes on imported goods, tariffs typically lead to higher consumer prices. However, this initial price bump is just part of the story; tariffs can drive longer-term inflation by facilitating profit-led price increases, contributing to wage inflation, reducing market competition, and disrupting supply chains.

The Dynamics of Profit-Led Inflation

Tariffs often lead to profit-led inflation when businesses use the added import costs to justify larger price increases than necessary. For example, a 10% tariff on the import price—which is usually much lower than the consumer price—should theoretically result in a less than 5% retail price hike. However, companies often inflate prices beyond this, capitalizing on consumer expectations and effectively padding their profit margins.

Wages and the Risk of a Wage-Price Spiral

The increase in consumer prices can, in turn, influence the labor market. As workers see their purchasing power diminish, they may push for wage increases to offset the rising cost of living. When tariffs impact a wide range of products and sectors, these wage demands can become widespread, leading to a wage-price spiral—a scenario where rising wages and prices continuously feed off each other, making it harder to stabilize inflation.

Reduced Competition and Market Impact

Tariffs also tend to diminish market competition by creating barriers for imported goods. UBS notes that when foreign competitors face tariffs, they may struggle to compete in the domestic market or even exit it entirely. Even after tariffs are lifted, companies may be hesitant to reenter markets where they previously faced protectionist barriers, resulting in lasting damage to competition and allowing domestic firms to raise prices more freely.

Supply Chain Disruptions and Broader Economic Effects

Additionally, tariffs can disrupt global supply chains by increasing the costs of imports, particularly in industries with complex production networks, such as electronics and automobiles. The resulting supply-side inflation can be particularly damaging, as it not only raises prices for individual products but also creates bottlenecks and inefficiencies across the economy, further increasing costs.

Policy Considerations Amid Inflation Risks

UBS analysts underscore the importance of considering these inflationary risks. Tariffs, while serving as tools to protect domestic industries or generate government revenue, may reignite inflation at a time when it seems to be stabilizing. For governments and central banks, managing these risks will be essential to maintaining economic stability and avoiding a return to a high-inflation environment.