Trump, tariffs, and European defence spending cloud ECB meeting outlook

The impact of a potential trade war with the United States and massive increases in European defence spending and government borrowing loom over a policy meeting Thursday at the European Central Bank, which is expected to cut interest rates by a quarter percentage point.

Analysts are widely expecting a cut in the European Central Bank's (ECB) benchmark deposit rate to 2.50 per cent, a step to lower borrowing costs for consumers and businesses in an economy that's struggling to get out of first gear.

The bank's monetary policy statement and post-meeting news conference by President Christine Lagarde will be scrutinised for hints about how far the bank will cut rates amid concerns about weak growth. The bank has already reduced the benchmark rate by 1.25 percentage points since June.

Meanwhile new concerns that would massively reshuffle the economic picture are likely to intrude: the potential impact of new tariffs on European imports from US President Trump, which could slow growth, and plans for massive new defence spending and borrowing, which could mean more growth but also more inflation.

Those two forces could push the ECB in opposite directions: a hit to growth would call for lower rates, while more persistent inflation would argue for keeping rates higher in coming months.

Growth estimates for Germany, the eurozone's largest economy, shot up overnight and long-term interest rates rose following an agreement by the two parties that will form the country's next government to loosen constitutional limits on borrowing and exempt defense spending.

That is a major turnaround in German budget policy and opens the way for a trillion or more in new borrowing and spending over the next decade.

Also in the mix are concerns that Trump will impose new tariffs on European goods, hurting growth in an export-dependent economy.

The 20 countries that use the Euro currency and for which the ECB determines interest rate policy stagnated in the last three months of the year, showing zero growth. Consumers burned by an earlier outbreak of inflation remain cautious, while businesses have been unsettled by concerns about what Trump may do.

Christine Lagarde will most certainly be asked about how the ECB intends to respond to these moves and the support that the central bank may provide to the bloc, said Julien Lafargue, chief market strategist at Barclays Private Bank.

He predicted the ECB would stay flexible and decide based on incoming data: "Indeed, the possible push, in terms of GDP growth, from higher government spending may be offset by the pull coming from US tariffs and the net effect is unclear.

Economists at Deutsche Bank predict the ECB will cut rates to 1.5 per cent by the end of the year: Our assumption is the negatives of a trade war dominate the positives of defence spending in 2025.