ECB cuts rates again to help economy weather US policy

The European Central Bank (ECB) cut interest rates for the seventh time in a year on Thursday and warned that economic growth will take a big hit from US tariffs, bolstering bets for even more policy easing in the months ahead.

The ECB has taken borrowing costs to their lowest level since late 2022 as the sharp post-pandemic inflation spike has largely disappeared and fast-moving changes to trade policies sap business confidence and depress growth.

“Downside risks to economic growth have increased,” Lagarde told a press conference after policymakers agreed unanimously to cut the ECB’s benchmark rate by 25 basis points to 2.25%.

While US President Donald Trump has paused most tariffs, many remain in place and volatility in financial markets has already done damage, justifying a 25 basis point cut to 2.25 per cent, the vast majority of economists polled by Reuters said.

“Cutting the deposit rate 25 basis points to the top of (the neutral) range should be straightforward given the huge uncertainty and the likelihood that the trade war is not just a supply shock but will also likely hit demand,” JPMorgan economist Greg Fuzesi said.

The ECB earlier estimated that growth across the 20 countries that share the euro currency could fall by a half a percentage point if tariffs are imposed, erasing about half the bloc’s expected expansion.

That estimate could still prove too optimistic if Trump reverts to bigger trade barriers or if the European Union retaliates.

The turmoil caused by erratic US trade policy could also weigh on prices and help the ECB get inflation back to target quicker as nearly all financial indicators impacting prices shifted dramatically in recent weeks.

The euro has firmed 9 per cent amid the volatility and trades at an all-time high on a trade-weighted basis, energy prices are sharply lower, growth is slowing, and China, the number one target of US tariffs, could dump some of its output on Europe.

Morgan Stanley argues that based on prevailing financing conditions, inflation could even fall below the ECB’s 2 per cent target.

“The revised assumptions push headline meaningfully down, below 2.0 per cent from the second quarter onwards,” it said. “And euro area inflation would potentially be below target for most of 2026.”

A final argument for a rate cut is that investors have fully priced in a move and the ECB will not want to upset already jittery markets. Investors then see at least two more steps this year with some even pricing a third as growth falters.

While a rate cut is fully priced in, investors will sift through Lagarde’s comments at a 1245 GMT press conference for clues about future policy.

They will want to see if the ECB maintains a reference to rates being restrictive. Such a phrase would signal that more policy easing remains the baseline.

They are also looking for a possible update on the impact of trade barriers. While Lagarde offered some numbers late last month, ECB staff was working to refine estimates and she may choose to share more, even though new official projections are not due until June.

Investors will also want to see if she offers any signal beyond the usual that ECB decisions are “data-dependent” and will be taken “meeting by meeting”.

Finally, Lagarde is likely to be asked if the central bank can estimate the impact of an expected surge in German government spending under the new coalition government, which has promised big defence and infrastructure investments.

Lagarde is likely to deflect these questions, however, as the ECB tends to estimate only the impact of enacted policy rather than proposals.

The spending is nevertheless likely to boost both growth and inflation further out, possibly forcing the ECB to reverse rate cuts.

UBS economist Reinhard Cluse argues that the ECB will need to start hiking borrowing costs next year to prevent this fiscal stimulus from pushing prices up again.

“We believe the ECB might have to hike rates again in late 2026 to prevent an overshooting of inflation in 2027,” Cluse said.

“We factor in two hikes of 25bps each in September and December 2026, to 2.5 per cent, moderately above neutral.”

Despite the ECB’s current dovish stance, markets are already bracing for an eventual pivot. Analysts caution that a prolonged period of ultra-low rates could sow future instability, especially if inflationary pressures return more aggressively than forecasted. With Germany’s anticipated fiscal expansion looming and geopolitical uncertainties still unfolding, policymakers will need to strike a delicate balance. The ECB must remain agile — prepared to stimulate further if recession risks deepen, yet ready to withdraw support swiftly should inflation rebound.

Agencies