Is the "interest rate cut on Thursday" a done deal? How will Trump's return influence the European Central Bank's view on tariff risks? Where is the endpoint for interest rates? What impact will rising inflation have on decision-making? How will the response be if the Federal Reserve stops cutting rates? Under the shadow of tariff threats from the USA, the Eurozone may face a more complicated outlook amidst an already weak economy...
With Trump's return to the White House, the European Central Bank (ECB) will hold its first policy meeting of the year this Thursday, and traders expect that further interest rate cuts by the ECB are a foregone conclusion. Analysts believe that the current focus is on the potential impact of U.S. tariff threats, which could complicate the eurozone’s already fragile economic outlook.
In this context, analysts point out that the ECB faces five key issues:
What action will the ECB take on Thursday?
Analysts believe that the market widely expects the ECB to cut interest rates by 25 basis points again this Thursday, lowering the key rate to 2.75%, and this expectation has already been fully absorbed.
Frederik Ducrozet, Head of Macroeconomic Research at Pictet Wealth Management, stated that the economic outlook has not changed since December last year.
How does Trump's return affect the ECB's view on tariff risks?
So far, economists believe the impact is limited.
Analysts believe that although Trump has not immediately implemented tariffs, he has targeted Canada and Mexico and complained about the Trade conditions with the EU. For the European Central Bank, the key lies in how tariffs affect inflation in the eurozone. European Central Bank President Christine Lagarde stated last week that the bank is not "overly concerned" that Trump's policies will export inflation to Europe.
Economists from the Dutch bank indicated that the European Central Bank will consider that tariffs mainly have a negative impact on growth.
To what extent does the European Central Bank need to lower interest rates?
Traders expect the European Central Bank to cut interest rates nearly four times this year, with some policymakers explicitly agreeing that rates will be lowered to around 2%.
However, some hawks are cautious about the pace of interest rate cuts. PIMCO portfolio manager Konstantin Veit believes that once rates reach 2.5%, the European Central Bank will need to think more deeply about the next steps. However, he added that due to economic weakness, the risk of rates dropping to 1.75% is substantial.
Lagarde stated last week that the neutral level is between 1.75% and 2.25%.
How much impact does rising inflation have on the European Central Bank?
Economists believe this is not too concerning. Although the inflation rate rose to 2.4% in December, driven by rising Energy prices and service costs, reaching a new high since July, and the service sector's inflation rate has remained around 4%, the rise in the inflation rate is consistent with the European Central Bank's expectations.
Chief Economist Philip Lane stated that he believes wage growth is slowing down, which will quickly reduce inflation in the service sector. He also warned that maintaining excessively high interest rates for a long time could cause the inflation rate to fall below the target.
How will the European Central Bank respond if the Federal Reserve stops lowering interest rates?
Analysts believe that the European Central Bank may slow down the pace of interest rate cuts, but this will depend on the reasons for the Federal Reserve stopping the cuts.
Ducrozet from Pictet pointed out that if the USA does not lower interest rates due to a strong economy, it would also be good news for Europe, and the European Central Bank might reduce the extent of rate cuts. However, if it is due to a stagflation scenario, the impact on the European Central Bank may not be significant.
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