ECB Policymakers Breathe a Sigh of Relief as Trump Holds Back on Tariffs
The European Central Bank (ECB) is likely to be relieved that the new US administration has not imposed blanket trade tariffs, paving the way for a potential rate cut next week. US President Donald Trump’s decision to hold back on trade barriers has sent a wave of optimism through the markets, with the euro surging, oil prices plummeting, and yields falling.
A Done Deal?
Financial investors had been pricing out ECB rate cuts in recent weeks, fearing that a strong dollar, rising energy costs, and retaliatory trade measures from the EU would push up domestic inflation. However, with Trump’s threats largely focused on Mexico, Canada, and China, investors are now more confident that the ECB will continue cutting rates.
A Shift in Market Sentiment
Investors had braced themselves for the worst possible outcome, including the announcement of universal tariffs. However, with the initial comments from Trump appearing better than feared, market sentiment has shifted. “Most of the comments were related to ‘America’s first’ policy, but the initial comments appear better than feared by the market,” said Mohit Kumar at Jefferies.
Rate Cuts Ahead?
Kumar predicts that the ECB will cut rates by 25 basis points each in January and March, with a possible skip in April and another cut in June. Investors have now fully priced in four rate cuts from the ECB this year, a significant shift from recent days when a fourth move was seen as highly uncertain.
The Dollar’s Impact
The dollar’s relentless rally since November’s US election has been a major factor in market bets moving so much. The currency’s strength risks boosting European inflation, particularly since energy is priced in dollars and exchange rate movements immediately show up in household costs. However, the dollar index is now down 1.3% from its highs last week, and may not have yet hit bottom.
A Temporary Setback?
While investors are aware that policy can change quickly under Trump, some economists argue that the ECB is bound to keep cutting rates, even if Trump hardens his stance on the EU. Tariffs, which would only curb but not erase the EU’s massive current account surplus, would weaken economic growth and the deflationary impact of that could more than offset the inflation caused by new duties.
The ECB’s Resolve
“If anything, Trump’s policies could strengthen the ECB’s resolve to cut rates due to their negative effects on the euro area growth outlook,” said Nordea. The bank predicts three further 25 basis points rate cuts from the ECB, with risks tilted towards the rate cuts continuing for even longer than this.
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