The European Central Bank (ECB) is set to reduce its interest rate further this week due to economic concerns. Meanwhile, Donald Trump has vowed to impose 25% tariffs on the EU, sparking concerns of a further growth slowdown.
The ECB is widely expected to lower interest rates further on Thursday as economic concerns outweigh stubborn inflation. The cut will bring its key benchmark rate, the deposit facility, down to 2.5% following a full percentage reduction last year and a 0.25% cut in January.
Europe faces further economic and political challenges
The rate decision comes in a week when 25% tariffs on Canada and Mexico are set to take effect, and US President Donald Trump has decided to add an additional 10% levy on Chinese goods, bringing the total import duty to 20%. These tariffs will heavily impact the European economy due to its wide exposure to global markets.
Trump has also threatened to impose 25% tariffs on EU imports, sparking concerns of a further growth slowdown after the eurozone’s economy stagnated in the final quarter of 2024. Meanwhile, Trump’s clashes with Ukrainian President Volodymyr Zelenskyy at the White House have heightened Europe’s challenges. The Kiel Institute has estimated that blanket 25% tariffs on the EU could shrink its real GDP by 0.4% in the first year. According to the European Commission, tariffs of 25% on steel and aluminium alone would affect €28 billion worth of exports.
Gross Domestic Product (GDP) contracted in Europe’s two largest economies, Germany and France, in the final quarter of 2024. Germany’s economy shrank for the second consecutive year in 2024. Europe’s largest economy was hit hardest by the Russia-Ukraine war, with soaring energy prices weighing on its manufacturing sector. Germany’s automakers, already under pressure, would be particularly affected by Trump’s tariffs.
The EU’s inflation data in focus
The March flash Consumer Price Index (CPI), due this week, will be a critical economic indicator shaping the ECB’s rate decision. Inflation in the eurozone rose for the fourth consecutive month to 2.5% in January, as cold weather increased energy demand and lifted prices. Despite this, ECB President Christine Lagarde stated that inflation was on track to reach the 2% target level in the medium term. She also warned that the eurozone’s economy “is set to remain weak in the near term.”
Annual inflation is expected to ease to 2.3% in February, as energy prices retreated due to milder weather conditions. Core CPI, excluding volatile items such as energy and food, is forecast to be 2.6% in February, down from 2.7% in January. Both figures are likely to further support the case for another ECB rate cut. According to a Reuters consensus forecast, the central bank is expected to reduce interest rates by a further 50 basis points after this week’s widely anticipated cut, bringing the deposit rate down to 2% by year-end.
Euro weakens, European stock markets outperform
The euro fell to 1.0375 against the US dollar last Friday, its lowest level since 13 February. Trump’s tariff threats have continued to boost the dollar on expectations of rising inflation. The ECB’s more dovish policy stance, compared with the Federal Reserve’s, has also weighed on the common currency. Market participants anticipate that the EUR/USD pair could reach parity at some point this year. However, a trade war would benefit neither party, instead increasing inflationary pressure and complicating central banks’ interest rate decisions.
Ironically, European stock markets have outperformed their US counterparts this year, with the Euro Stoxx 600 index up nearly 10% and the DAX rising 13%, while the S&P 500 has gained only 1.5%. Despite economic and political challenges, expectations for lower interest rates have been a key factor driving the market rally. Additionally, European defence stocks have surged since Trump initiated peace talks with Russia and urged Europe to increase military spending, which has strongly contributed to market gains.
