The European Central Bank (ECB) is immersed in a cycle of rate cuts in a situation that few could have expected just a year ago. Inflation is falling faster than expected and the threats on the horizon for the Eurozone economy continue to grow. Simply put: falling inflation and economic stagnation can only have one response from the ECB, which is lower prices as much as necessary. According to a recently released report by Deutsche Bank, at present, the The “final rate” (the last of the reduction cycle) of the ECB will be between 1% and 1.75%a range well below the previous forecast of 2.25%. “We are reducing our central forecast for the final rate from 2.25% to 1.50%,” although the floor could be even lower. The German bank’s analysts thus join other strategists who have been announcing for weeks a final rate below 2%, as did Mathieu Savary, chief strategist at BCA Research, in statements to elEconomista.es.
Deutsche Bank economists identify four key factors that will influence the direction of the ECB’s monetary policy: fiscal policy, the economic situation in Germany, developments in China, oil prices and future tariffs American customs officials. In this context, they emphasize that “The global economy could enter a different regime, with macroeconomic conditions in Europe increasingly diverging from those in the United States.”
The decision to reduce the final interest rate also responds, in part, to the impact of possible customs duties imposed by the new Trump administration in the United States. “The prospect of higher US tariffs threatens a new terms of trade shock,” warn the economists, who also point out that these tariffs could trigger an increase in prices. economic uncertainty, similar to the situation experienced in 2018-2019 during Trump’s first term. The eurozone is a net exporter and much of its citizens’ income comes from a high current account surplus. Tariffs threaten to reduce this surplus and hamper growth on the European continent.
The United States is the main trading partner (in terms of value added) of the EU, with 15% of exports, and of the United Kingdom.with 18% (although the EU as a whole is higher). Thus, any attempt by the new US administration to impose universal customs tariffs could have a direct and significant impact on demand for European exports.
“Its scope is difficult to assess, because it is still unclear whether President-elect Trump will impose tariffs on European exports and, if so, at what level, after probably long and difficult negotiations that could lead to measures “But a possible loss of consumer and business confidence if the tariffs remain in place could have an even greater impact on the economy,” UBS analysts Dean Turner and Matthew Gilman warn in a report. note in which they also defend that the Eurobank should reduce. more than they had expected. The President of the ECB, Christine Lagarde, herself explicitly stressed that Trump represented a risk for growth during the press conference of the last meeting of the central bank.
Although the European economy has shown signs of resilience, with positive GDP growth in the first three quarters of 2024, underlying macroeconomic data is weak and growth projections for the coming years have been revised to the decline. “We forecast euro zone GDP growth of 0.7% in 2024 and 1% in 2025, figures lower than previous expectations,” underlines Deutsche Bank. This is partly due to the slowdown in the German economy, which is facing structural challenges to competitiveness and a loss of confidence. Weakening household demand and falling business investment in the short term also threaten the UBS economists’ 1% growth estimate downwards.
The old problems of the return of inflation
The report also highlights concerns about inflation… not because it will be very high, quite the contrary. According to calculations by Deutsche Bank, headline inflation in the eurozone could fall below the 2% target around the start of 2025, six months ahead of the BC forecastE. However, analysts emphasize that “we are not overly concerned about a significant and persistent deviation in inflation”, as several indicators of underlying inflation remain stable around the 2% target. The sharp drop in the price of oil since the summer until today has caused general prices to lose intensity much more sharply than expected.
The uncertainty surrounding US tariffs also extends to their possible impact on inflation. “We estimate that universal tariffs of 10% could have little net impact on European inflation, as the hit to growth is disinflationary, but it could be offset by the pressure of the tariffs themselves and by the weakness of the euro”, they explain.
The real source of uncertainty regarding inflation lies in the indirect effects of the 50-60% tariffs on China and whether and to what extent this will trigger dumping of exports to Europe. “This could further affect European growth by expelling European production and subtracting up to half a point from the Eurozone CPI, according to a recent ECB analysis,” they say from Deutsche Bank. “A policy response from China that results in increased production and supply of goods to economies outside the United States could worsen disinflationary pressures in Europe,” corroborate UBS’s Turner and Gilman.
“The economy is unlikely to improve as a wait-and-see attitude may prevail among export-oriented companies. 10% tariffs on European goods are probably manageable, but 60% tariffs on Chinese goods could be very disruptive, either by reducing Chinese demand or triggering a massive devaluation of the yuan, and/or by encouraging Chinese producers to compete more strongly with European suppliers outside the American market”, goes in the same direction, Gilles Moëc, chief economist at AXAin a comment advocating an acceleration of ECB rate cuts.
Spending cuts are coming… in principle
On the fiscal side, Deutsche Bank economists point out that austerity policies applied in countries like France could have a negative impact on the recovery, while other economies could suffer. The fiscal adjustment needed in some countries could weigh on the eurozone economy as a whole. “The greater amount of public saving combined with a high level of private saving could hamper economic recovery,” they say.
The situation in Germany, Europe’s largest economy, remains crucial for the euro zone. “Germany is experiencing a confidence shock, perhaps reflecting structurally weak competitiveness,” the report notes. The German economy could face a further decline in investment and employment, which would dampen economic growth in the region.
“We have recently seen some contagion from US long-term yields to European yields, and this will not help Europe’s fiscal equation. This is another reason why the ECB will have to ‘compensate’ with faster cuts. Fortunately, “It seems that even the hawks are changing their minds at the ECB,” says AXA’s Moëc.
The analyst believes that European national governments are not in an ideal position to reassure or guide, as France and Germany are both in the midst of internal political difficulties, while European populists will want to accentuate their advantage. “The ECB is the only European institution with the capacity to react quickly in the current configuration,” he underlines.
The forecast for The ECB’s terminal rate, that of Deutsche Bank, is now between 1% and 1.75%reflects this whole context. German analysts emphasize that “it is essential to underline the high degree of uncertainty surrounding the future development of growth, inflation and monetary policy.” According to the report, this downward revision of the terminal rate suggests that the ECB could lead to larger cuts in interest rates at its next meetings to reduce the gap between current rates, considered restrictive, and the desired level more neutral, even slightly. expansive.
At this point, Deutsche Bank warns that the ECB could decide to implement cuts of up to 50 basis points instead of the expected 25 points, depending on the data that arrives in the coming weeks. Hypotheses that other eminent analysts adhere to. “We agree that the outlook for US protectionism in 2025 makes it more likely that the ECB will cut rates by 50 basis points in December this year. And we forecast a final rate of 1.75% in 2025 – perhaps as early as the second quarter of next year – while European decision-makers place rates in a slightly accommodating zone”, say those at ING. Its economist Michiel Tukker is clear: as the ECB’s reaction function shifts more towards growth concerns, the chances of a 50 basis point cut later are now more likely.
