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ECB Faces Economic Crossroads Amid U.S. Tariff Threats

LONDON (Reuters) – The European Central Bank (ECB) convenes this Thursday for its first meeting since Donald Trump re-assumed the U.S. presidency, amid concerns regarding the impact of potential tariffs on the already sluggish euro zone economy. These developments could complicate the region’s financial strategies.

Market analysts widely anticipate a reduction in rates, but they are keen to decipher any fresh guidance from the ECB regarding future monetary policy.

“We expect President Christine Lagarde to indicate that further rate cuts are being considered,” noted Bruno Cavalier, chief economist at Oddo.

Key Questions Facing the Markets

1. What Actions Will the ECB Take on Thursday?

Most analysts foresee a 25 basis point cut in the key deposit rate, bringing it down to 2.75%. This move is currently reflected in market pricing, particularly after the ECB modified its guidance in December to remove language committing to keeping rates high.

Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, commented, “There hasn’t been any shift in the economic outlook since December.”

2. How Will Trump’s Return Influence ECB Views on Tariffs?

Current projections suggest that Trump’s presidency hasn’t shifted ECB economists’ perspectives on tariff risks.

Although President Trump hasn’t enacted immediate tariffs and indicated a lack of readiness for widespread tariff implementation, his administration has positioned Canada, Mexico, and China as key scrutiny targets, while voicing dissatisfaction regarding trade agreements with the European Union.

In a recent statement to the World Economic Forum via video, Trump asserted that other countries may face tariffs if their products are manufactured outside the U.S.

While certain analysts express relief at the measured initial approach, the situation remains fluid. The ECB’s main concern revolves around how tariffs could influence inflation in the euro zone, whether directly or indirectly through their effect on demand.

Lagarde earlier expressed that the ECB is not excessively worried about Trump’s policies leading to inflation transmission to Europe. Economists at ABN AMRO interpreted her comments as an indication that the ECB views tariffs primarily as detrimental to growth.

3. What Is the Required Rate Cut Level for the ECB?

Market participants are speculating about nearly four further rate cuts from the ECB this year, with some policymakers suggesting a drop towards a target of 2%. This range aligns with estimations of the neutral interest rate, which neither restricts nor stimulates growth.

However, some more hawkish members of the ECB caution that the pace of cuts should be carefully considered, as Isabel Schnabel recently highlighted the need for in-depth analysis regarding the extent and rapidity of rate reductions.

According to PIMCO portfolio manager Konstantin Veit, a drop to 2.5% would warrant a more considered approach moving forward, despite the weak economic landscape suggesting rates could potentially reach as low as 1.75%.

4. Should the ECB Be Concerned About Rising Inflation?

Prospects of inflation rising to the highest rate since July at 2.4% in December do not seem overly alarming to economists, despite being driven by increasing energy costs and persistent service-related inflation around 4%.

This uptick aligns with ECB forecasts, and Chief Economist Philip Lane remains confident that wage growth will decelerate, consequently reducing inflation in the services sector.

Lane has highlighted potential risks of maintaining elevated rates for too long, which could drive inflation below the target threshold. While the ECB primarily targets inflation nearing 2%, the broader context of economic growth remains crucial for forecasting inflation trends, as emphasized by Danske Bank chief analyst Piet Christiansen.

5. What If the Federal Reserve Halts Rate Cuts?

The ECB may consider slowing its own rate reductions depending on the circumstances surrounding the Federal Reserve’s decision-making.

Market expectations regarding the Fed’s rate cuts have oscillated in January due to uncertainties tied to U.S. inflation projections. Institutions like Bank of America and BNP Paribas anticipate the Fed will maintain current rates throughout the year.

Pictet’s Ducrozet noted, “If the Fed refrains from cutting rates due to economic strength in the U.S., it could posit positive implications for Europe, potentially leading the ECB to temper its cuts.” He further elaborated that if the Fed doesn’t cut rates due to a stagflation scenario, it might not materially affect the ECB’s direction.

Source
finance.yahoo.com