A quarter-point ECB interest rate cut on Thursday is fully priced in by traders and markets. That would be the eighth reduction in a year and take the key deposit rate to 2%. The question now is whether the ECB pauses as rates are now in neutral territory amid high trade war uncertainty. The chances of any policy guidance from the Governing Council and President Lagarde are highly unlikely, which will clearly leave the ECB watching developments, regarding tariffs especially, with some conditionality on the new economic staff projections.
The eurozone economy is holding up better than anticipated and surprised to the upside in the first quarter, with frontloading effects due to potential tariffs significant. Pausing policy moves allows rate setters time to assess the impact of these tariffs, certainly with the easing and (rising) of tensions between US and China. Of course, EU – US talks are front and centre and the 50% pause to July 9 is positive, but large gaps remain between the two sides.
The strengthening of the euro exchange rate and the drop in oil prices as a result of inconsistent US economic policy have increased disinflationary pressures in the eurozone. The spike Iin core inflation in April appears to have been mainly due to Easter effects. More broadly, there has been notable resilience in manufacturing indicators, improving global trade talks and a significant easing of financial conditions.
Divisions to become more clear
Differences between the hawks and doves may widen now that the deposit rate has reached neutral levels. The hawks, like Schnabel and Holzmann, have become more vocal in calling for more caution in the policy easing cycle. The unexpected economic resilience, as well as an even less clear outcome in the trade negotiations and tariff announcements, supports their case. On the flip side, in recent remarks, Chief Economist Lane said he was confident that the bank’s task to bring inflation back to 2% is “mostly completed”.
For the accompanying macro projections, most economists expect growth to be revised down a touch for both 2025 and 2026 (currently at 0.9% and 1.2% respectively), while the inflation view is likely to be trimmed for 2025 to 2.1% (from 2.3%) and to 1.8% in 2026 (from 1.9%). This should on balance favour the doves, though a higher core inflation 2025 print will give the hawks a morsel to feed off.
President Lagarde will likely be much less clear on where the ECB is heading compared to the April meeting. Any hints on what comes next will be critical, while her own position may come under some scrutiny due to press reports about a possible early exit from the ECB to the World Economic Forum. Similar to other central banks, a ‘wait-and-see’ stance is probable, in order to assess the growth and inflation outlook. It will take a bit longer to understand whether the current disinflationary risks from tariffs are merely one-offs or whether they signal a broader trend. Some hawks may also be worried about the inflationary impact of German fiscal stimulus next year.
Market pricing
Economists and markets expect the ECB to hold steady come July before cutting once more before year-end with around 55bps of cuts priced in for 2025. Any de-escalation in trade tensions will cap more dovish bets while a ratcheting up could see markets aggressively lower their year-end rate closer to 1.5%. The euro has fared well in the trade uncertainty as it offers an escape away from the dollar. The bull target is the recent three-year high at 1.1572.