Tariffs clear the way for European Central Bank interest rate cut

The European Central Bank is widely expected to trim interest rates for the third time this year as global tariff tensions and uncertainty threaten the euro zone’s economic growth.

As of Wednesday, markets were last pricing in a roughly 94% chance of a quarter-point interest rate cut from the central bank and a close to 6% likelihood of a larger, 50-basis-point reduction according to LSEG data.

A quarter-point cut would take the ECB’s deposit facility rate, its key rate, to 2.25% — down from a high of 4% toward the middle of 2023.

The series of relatively fast-paced interest rate cuts have played out as inflation in the euro area has consistently sat below 3%, recently closing in on the ECB’s 2% target. Regional economic growth has meanwhile been lackluster.

When the central bank last cut rates in March, it tweaked its language around monetary policy, which it said was “becoming meaningfully less restrictive.” In January, the ECB had still characterized monetary policy as “restrictive.”

The shift in language was interpreted by some economists as a signal that policymakers were becoming more careful about taking interest rates further lower, stoking questions whether a pause to the monetary easing cycle could lie ahead. But the global trade and tariff roller coaster of the last few weeks has somewhat shifted this view.

“After the March meeting, the ECB seemed set for a pause at the next meeting. With interest rates at the upper end of the range for neutral interest rates estimates, taking a breather looked appropriate,” Carsten Brzeski, global head of macro at ING, said in a note Monday.

“Particularly as the europhoria after the German fiscal u-turn and strong European intentions to spend more on security and defence had clearly improved the eurozone’s growth outlook. However, since ‘Liberation Day’, a pause is no longer an option,” he said, suggesting that global tariff policies have prompted renewed concerns about euro area growth.

And so, the “ECB is forced to cut,” Brzeski assessed.

Many of the announced tariff plans from the U.S., along with retaliation measures revealed by Washington’s trading partners, have been put on hold or reduced — at least temporarily — since they were first imposed earlier this month by President Donald Trump. But the outlook for trade, tariffs, and the potential macroeconomic fallout are still murky, Ryan Djajasaputra, economist at Investec, indicated in a note.

“Uncertainty remains high and there is still no guarantee individual countries or the EU will be able to agree deals with the US. Nor is there certainty that the US President will not change his policies again in the future, such is the nature of the current environment,” he said, suggesting this supported the case for an interest rate trim.

After already softening their language around how restrictive rates still are in March, the ECB could again make tweaks Thursday.

ING’s Brzeski said the central bank would “have to change its communication,” suggesting the central bank would flag that a lower 2.25% deposit rate, “would now be within the range of neutral interest rates” if the ECB opts for a further trim.

The topic of where the so-called neutral rate lies for the ECB has been hotly debated for months now, among policymakers, analysts and economists. At the neutral level, interest rates neither stimulate nor restrict the economy and can be kept steady.

The ECB estimates its neutral rate sits between 1.75% and 2.25%.

Economists at Deutsche Bank research appeared more hesitant about any potential language shifts, saying they believed the language would remain unchanged Thursday. “In combination with the view that inflation is returning to target, this has an implicit dovish leaning.”

Looking beyond the Thursday ECB decision, the path ahead for interest rates is expected to be “open-ended,” Deutsche Bank research economists argued.

They do not see the ECB’s wording around the outlook for rates changing from that of policymakers saying they were not pre-committed to a specific rate path and would make decisions in a data-dependent way each meeting.

“This open-ending wording allows the policy stance to remain restrictive, move to neutral or turn stimulative depending on the data,” they said, adding that this technically means that it was possible for the ECB to pause interest rate trims in June.

The economists’ projections nevertheless assumed further rate cuts.

Much in terms of the policy path ahead will depend on the U.S. and developments in global trade, Investec’s Djajasaputra suggested.

“Beyond April’s meeting, the outlook for ECB interest rates is one clouded by and beholden to White House policy decisions,” he said, adding that he expected a further rate cut later this year — though the timing of that step would depend on upcoming economic data and on other economic developments.