European Central Bank rates could fall faster as recession risk mounts

A global market rout induced by US President Donald Trump’s tariffs scheme has solidified the case for another ECB rate cut next week and supports arguments for even quicker policy easing from the world’s second largest central bank.

The expected economic slowdown induced by the tariffs along with the fallout from the market volatility are likely to be such a drag on prices that they will likely outweigh the inflationary impact of any retaliatory measures by the EU, economists say.

Markets now see almost two rate cuts in the European Central Bank’s next two meetings and see between three and four steps between now and the end of the year. German bond yields, the euro zone’s benchmark, were once again falling on Monday as markets priced in a recession in the bloc and monetary easing to deal with it.

While ECB policymakers are far from a consensus on what it all means in the longer run, the rout makes next week’s rate cut a near certainty and interest rates could fall far deeper this year than earlier thought without jeopardizing the 2% inflation target.

In fact, the market turmoil is so great, a recession is now a real possibility and propping up growth could soon become a bigger concern than inflation, which has run above the ECB’s target for the past four years.

“They have to cut at every meeting, if only because of the uncertainty,” Frederik Ducrozet at Pictet Wealth Management said. “There is no sign of increasing inflationary pressure over the longer term.” A raft of influential ECB policymakers, including Pierro Cipollone, Francois Villeroy de Galhau and Yannis Stournaras have all called for more policy easing in the current environment and none of the key hawks have pushed back.

Speaking in private, some policymakers even questioned the ECB’s own projection that tariffs plus the EU’s own retaliation would only lower growth by a half a percentage point in the first year and argued that the impact would be larger.

Indeed, oil prices were sharply lower on Monday, yields were down, gold was down and longer-term inflation pricing was falling, a combination of market moves suggesting that a recession is now expected.

The EU is - for now - prioritising negotiation over retaliation versus the US.

However, more hawkish ECB policymakers, speaking in private, argue that the central bank may be underestimating the inflationary impact of the tariff measures and its prediction of a short-lived price effect may be off.

They argue that tariffs mean less trade, new value chains and higher costs, all pointing to higher underlying inflation in the longer term, much like in the decades before globalisation.

The ECB has long said that rate cuts are its primary policy tool but the bank also has a wide range of ready-to-use unconventional instruments in case the market rout morphs into a full meltdown.

The ECB will get nervous if bank lending is impaired, the yield differential between Eurozone member states rises to levels that are deemed unjustified and disorderly or if there is a surge in investment grade yields. The big difference compared to previous crises is that Trump controls the narrative and could end the turmoil with a stroke of a pen or could even make it far worse.

Agencies