The European Central Bank is expected to cut interest rates this Thursday and hint at further easing ahead as policymakers, together with the rest of the world, try to process the implications of U.S. President Donald Trump’s policies for growth.
The ECB is universally expected to cut the key deposit rate by a quarter-point to 2.75 percent on Thursday, and some Governing Council members have signaled they want it as low as 2 percent by June. But some analysts believe such signaling may embody little more than reassurance that the ECB will be there to support the eurozone economy if the U.S. does slap import tariffs on its exporters.
Eurozone inflation staged an unwelcome comeback in December to hit 2.4 percent, the highest level since July. However, policymakers had expected a temporary blip and have indicated they see the Bank’s baseline scenario as largely intact. This sees inflation reaching the ECB’s target of 2 percent in the course of this year, and is based on assumptions that the Bank will continue cutting its deposit rate gradually to 2 percent.
The economy, meanwhile, continues to sputter, only barely compensating for contraction in Germany and France with growth elsewhere around the bloc in January.
“As the projections are on track, there is a clear argument for delivering the cuts that are factored in,” said JP Morgan economist Greg Fuzesi.
Since last June, the ECB has lowered its deposit rate from a record-high 4 percent to 3 percent currently. Irrespective of the ECB’s commitment to “follow a data-dependent and meeting-by-meeting approach,” several policymakers — including influential French central bank chief François Villeroy de Galhau — hinted last week that they were in favor of back-to-back cuts until the deposit rate hits 2 percent over the summer.
The long tariff shadow
The Governing Council’s meeting will be overshadowed by the looming threat of U.S. tariffs. These could affect the eurozone economy in a variety of ways, either by hitting the eurozone’s exporters or in leading the European Commission to impose tariffs of its own in response.
Over the weekend, Trump demonstrated his willingness to deploy such measures to force trading partners to concede on other issues, threatening a 50 percent levy on Colombian exports after it refused to accept a plane deporting illegal immigrants back to their home country. The Colombian government immediately backed down and the tariff threat was lifted.
The Financial Times reported on Monday that incoming Treasury Secretary Scott Bessent has proposed setting tariffs on all imports into the U.S. at 2.5 percent initially, rising by a similar amount on a monthly basis, subject to negotiations with Washington’s trade partners. That would fall short of the worst-case scenario threatened by Trump before last year’s elections.
ECB President Christine Lagarde is due to meet Commission President Ursula von der Leyen this evening in Brussels, and while the ECB said their conversation will not touch on the Governing Council meeting this week, the threat of trade-related impacts on the economy has been a matter of mutual concern for months.
Where is ‘neutral’?
While analysts largely agree that an interest cut this week and in March are nailed on, they warned that any guidance beyond that may be premature, given uncertainty surrounding the economic outlook. By April, however, the ECB should at least have a much clearer picture of the kind of tariffs Trump will impose on Europe and whether they pose a meaningful threat to either growth or inflation.
The ECB is now openly talking about moving toward a “neutral” policy, from the restrictive one it has pursued for the last three years. However, pinpointing at what level interest rates are neutral — neither stimulating the economy nor holding it back — is an art rather than a science. The ECB estimates it could be anywhere between 1.75 percent and 2.5 percent.
ING’s global head of macro Carsten Brzeski argued that hitting the upper end of that range may prompt hawks to push for slower moves thereafter. As rates approach neutral territory, the debate is likely to become more heated. Dutch central bank chief Klaas Knot warned last week against straying into “stimulative mode.”
Similarly, Société Générale economist Anatoli Annenkov said that aggressive signals by policymakers last week may have been an attempt at “precautionary guidance ahead of potentially damaging U.S. trade policies.” But if the economy holds up, he said, the ECB may well feel “obliged to switch to quarterly rate decisions after March.”
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