EU's central bank to hold off on another rate cut to anticipate tariff blow

The European Central Bank will likely hold off on making another interest rate cut Thursday, choosing to wait until it can measure the size of any economic blow from higher US tariffs.

The ECB has already cut rates eight times since June of last year and President Christine Lagarde said after the last policy meeting June 5 that the central bank is getting to the end of a monetary policy cycle." 

  The monetary authority for the 20 countries that use the euro currency has been lowering rates to support growth after raising them in 2022-2023 to snuff out inflation caused by Russia's invasion of Ukraine and the rebound after the pandemic.

 

With the bench mark rate now at 2 per cent, down from a record high of 4 per cent, analyst think there could be one more rate cut coming, but only in September.

The reason, say analysts: The ECB's policymakers simply don't know the outcome of talks between the EU's executive commission and the Trump administration. 

 

Trump first set a 20 per cent tariff for EU goods, then threatened 50 per cent after expressing displeasure at the pace of talks, then sent the EU a letter informing officials of a potential 30 per cent tariff.

EU officials earlier held out hope of winning at least the 10 per cent baseline that applies to almost all trade partners, and analysts think that the actual rate may be lower than Trump's tariff threats. The talks are up against an August 1 deadline, but earlier deadlines have slipped as the sides kept talking.

The decision to hold rates unchanged will be uncontroversial among members of the bank's rate-setting council, said analysts at UniCredit's Investment Institute. 

 

In light of recent events, the risk of an adverse tariff scenario has increased since the June ECB meeting. The 30 per cent tariff on EU goods threatened by the US is much higher than generally expected, the UniCredit analysts wrote. "However, the response of financial markets to US President Donald Trump's letter to the EU has been muted, and this seems to reflect expectations that the landing point for tariffs on EU goods will be materially below 30 per cent.

With signs of economic activity holding up reasonably well, the ECB can afford to wait and see what the outcome of trade negotiations will be.

The ECB's rate cuts have helped support economic activity by lowering the cost of credit for consumers and businesses to purchase goods. Higher rates have the opposite effect and are used to cool of inflation by reducing demand for goods. 

 

Growth in the eurozone was relatively strong at 0.6 per cent in the first quarter - though that was partly due to rushed shipments of goods trying to beat the tariffs. Inflation has fallen from double digits in late 2022 to 2 per cent in June, in line with the ECB's target. A stronger euro, which lowers the price of imports, and softer global prices for oil have helped keep inflation moderate.

The stronger euro, up 13 per cent this year at USD 1.17, has attracted attention as a potential damper on growth and ECB Vice President Luis de Guindos said any rapid moves over USD 1.20 could be much more complicated.

But the ECB typically does not target the exchange rate, and the euro's rise is considered to be less the result of Europe's strength and more the result of a weaker dollar weighed down by investor uncertainty about the future path of inflation, growth and government debt in the US.