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The European Central Bank (ECB) cut interest rates for the seventh time since June 2024 today. The unanimous decision leaves the ECB’s headline deposit rate at 2.25%.
With inflation in the eurozone almost back to target, hitting 2.2% in March, the ECB also dropped the word “restrictive” from its narrative on the decision. This suggests it feels the deposit rate is close to neutral and will no longer weigh on growth going forward.
Trump’s tariffs will also drag on growth and be disinflationary in the medium-term, giving the ECB more room to cut interest rates this year.
We therefore expect two more 25bps cuts, which would leave the deposit rate at 1.75% at the end of the year.
Tariffs create room for more rate cuts
For three key reasons, it looks like inflation in the eurozone will hover around the 2% target in the eurozone for most of the year.
First, tariffs imposed by the US on the bloc will be disinflationary as growth slows. That’s because uncertainty will also weigh on consumption and investment domestically as confidence takes a hit. Additionally, tighter financial conditions will feed through into weaker borrowing and lending in the real economy and be a headwind to growth.
Reasons number two and three why inflation should stay manageable is that combining with this weaker growth are falls in commodity prices and a stronger euro making imports cheaper.
All of this suggests the ECB will be able to lean into a more material pace of easing to support the economy, with a risk that inflation could even slightly undershoot target.
What’s more, the European Union will probably start to see an increase in cheaper Chinese imports because the level of US tariffs is high enough to wipe out a significant amount of US-China trade. This will have a further disinflationary effect.
That said, this outlook assumes the bloc refrains from retaliatory tariffs, which would have a significant impact on inflation.
ECB president Christine Lagarde repeatedly emphasised uncertainty of the net effect of tariffs on inflation and the need for the governing council to stick to the principles of “readiness and agility in the face of uncertainty”. Translating from central bank speech, this means the ECB is hesitant to commit to further interest-rate easing as retaliation and potential disruption to global supply chains could quickly reverse the inflation outlook.
For now, we expect the EU to take stock and avoid implementing retaliatory tariffs.
Domestic inflation, defence and the neutral rate
Services inflation in the eurozone is also still 3.5%, reflecting more material domestic price pressures. Fortunately, services inflation has dropped quickly over the last few months. In December, the rate was still running at 4% before beginning a more material downwards trend. We think the ECB has probably squeezed enough out of inflation and that expectations look considerably better anchored elsewhere. So, while services inflation will cause the ECB to hesitate, it won’t stop them cutting to support growth.
Additionally, President Christine Lagarde’s statement today reiterated that “a boost in defence and infrastructure spending could also raise inflation over the medium term”. That may not be an immediate problem for the ECB, but could be down the line. As monetary policy continues to loosen and dip into expansionary territory to prop up growth, that big fiscal expansion as well as any retaliatory tariffs could see inflation pick up again.
For now, the battle against inflation in the eurozone is all but won. We expect the governing council to shift its view to support growth. Indeed, Christine Lagarde referred to calling policy restrictive as “meaningless at this point”, as rates now approach neutral. Concerns about running up against neutral will also virtually disappear as the bloc faces the prospect of slower growth and a growing tide of disinflation as investors lean into the euro as a relative safe haven while investors wait to see what happens next in the US.
The implications for Ireland
CPI inflation in Ireland jumped to 2% in March from 1.8%. The Irish economy remains far hotter than the rest of Europe. Growth has been consistently strong and the economy is still around the Irish Central Bank’s best guess at full employment.
However, all the disinflationary factors mentioned for the eurozone still apply to Ireland. Ireland is also far more exposed to the US, so the slowdown in growth from US tariffs will weigh far more on growth in Ireland than elsewhere in the eurozone.
A significant increase in trade barriers combined with US corporate tax changes could prompt multinationals to relocate some of their activity back to the US, which would have significant implications for growth and public finances.
Ultimately, we expect the ECB to cut interest rates two more times this year. That would leave the deposit rate at 1.75%, and below neutral, which we think is around 2%. Further US tariffs on key sectors such as pharmaceuticals could prompt even more easing.
