ECB prepares for June cut as economy hurt even if trade is fixed
Trump’s 90-day respite for negotiations will not be over before early July, and even then, it’s unclear if a lasting agreement can be reached
[FRANKFURT] European Central Bank (ECB) officials are preparing to lower interest rates further, expecting lasting damage to the economy from US tariffs even if Donald Trump’s administration softens its stance in the weeks ahead.
Following intense meetings at the International Monetary Fund (IMF) last week, most policymakers are leaving Washington disillusioned. They anticipate Trump’s unpredictable behaviour will continue to feed uncertainty, damping spending and investment – and ultimately inflation for some time to come.
The euro’s appreciation, tighter financing conditions due to increased fiscal expenditures and a drop in energy prices are also set to weigh on prices, strengthening the case for an eighth quarter-point rate cut in June. What happens thereafter will largely depend on updated inflation forecasts for next year and beyond.
Economists from Bank of America, Deutsche Bank and Morgan Stanley already see the deposit rate – currently at 2.25 per cent – falling to at least 1.5 per cent this year to stimulate demand.
While Governing Council members including Olli Rehn and Gediminas Simkus have signalled that they are open to considering taking borrowing costs towards such levels, others such as Klaas Knot and Martins Kazaks are cautioning against too much activism, arguing that the medium-term impact of recent events remains unclear.
President Christine Lagarde largely stuck to the ECB’s official line.
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“When the size and distribution of shocks are highly uncertain, we cannot provide certainty by committing to a particular rate path,” she told finance ministers and fellow central bankers on Friday (Apr 25). Earlier in the week, she said the ECB must be “data dependent in the extreme”.
Most of the latest reports are suggesting weaker growth momentum ahead. A survey of purchasing managers revealed depressed confidence and sluggish demand, and IMF projections downgraded expansion in the 20-nation economy to just 0.8 per cent this year from 1 per cent before.
Softer growth comes with lower inflation. The IMF, much like the ECB, predicts price pressures will hit 2 per cent sometime in the second half of the year. But compared to what transpired from some policymakers visiting Washington from Europe, its message is a more hawkish one.
Reaching the 2 per cent target “can be achieved with another 25 basis-point cut”, Alfred Kammer, the director of the IMF’s European department told reporters on Friday. “We don’t see a need for going lower than 2 per cent” in the absence of “major shocks”.
That threshold is perceived by economists to be the closest estimate of neutral, neither accommodating nor restricting demand. It could turn into a crucial mark that policymakers, especially the more hawkish ones, may be reluctant to cross.
“If inflation were to undershoot the target significantly and for an extended period of time, the natural choice would be to lower interest rates into stimulus territory,” Kazaks, who heads Latvia’s central bank, said in a Saturday interview. “Currently it is not the case.”
Knot, his Dutch colleague, argued in a speech on Wednesday that neutral “broadly remains the place to be”. While inflation may slow more rapidly than previously anticipated, he argued that the longer-term fallout from trade disruptions and higher European spending on defence and infrastructure is “far less clear”.
His comments suggest that the ECB on Jun 5 – the last meeting he attends before the end of his term – will be forced to lower next year’s outlook for consumer-price growth from the 1.9 per cent projected in March. But it’s the 2027 reading that will matter to assess whether prices are stable further down the line.
Despite the uncertainty, some of his colleagues are nearly ready to declare victory.
France’s Francois Villeroy de Galhau argued that “there is currently no inflationary risk in Europe”. His colleague Peter Kazimir from Slovakia concurred that inflation will be approaching its target in the coming months – instead of early 2026 as foreseen just last month.
Incoming data
In April, the rate probably dropped to 2.1 per cent, according to the median estimate in a Bloomberg survey before data on Friday. Two days earlier, Eurostat will publish a first estimate for the economy’s first-quarter performance, with analysts predicting 0.2 per cent growth.
These data will feed into the ECB’s next decision along with fresh forecasts. But while policymakers are eagerly awaiting the glimpse into the future they regularly provide, they are unlikely to capture the entire new equilibrium on trade. Trump’s 90-day respite for negotiations will not be over before early July, and even then, it’s unclear if a lasting agreement can be reached.
“It’s really important that we maintain full freedom of action, implying that we don’t define certain thresholds because of an assumed neutral rate, and we don’t a priori rule out a certain size of rate cut either,” Rehn, the head of Finland’s central bank, said. “This is a time for agile and active monetary policy.”
Asked about the option of a bigger move, chief economist Philip Lane said that “there’s no reason to say we are always going to do the default 25” basis-point steps, though he stressed it was a theoretical argument. Others said they did not see a need for such a step outside of exceptional circumstances.
Meantime, Estonia’s Madis Muller said there’s a possibility policy might have to be “a bit more accommodative” if trade uncertainty proves more damaging for growth.
But pessimism on the economy did not dominate sentiment for everyone.
Funds are flowing into the eurozone and bond yields have come down, said Boris Vujcic, the chief of Croatia’s central bank. “The current situation is not the worst scenario for Europe.”
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