ECB may continue to cut rates while Fed stands pat

While the US Federal Reserve has suspended its rate reductions since December, the European Central Bank is expected to continue its cutting Thursday.

There’s a simple reason why the ECB is moving further than the Fed: Europe’s economy is barely growing, while the US economy is buoyant. Eurozone GDP expanded only 0.7% last year, and the ECB isn’t looking for much of an acceleration this year – 1.1% growth. Meanwhile, the US economy expanded 2.3% annualized in the fourth quarter, though data have been mixed since then.

In Germany, the world’s third largest economy has barely grown for the last six years. Its focus on exports (43% of GDP) has proved troublesome amid slumping economies in the countries that import its goods such as China. Germany’s economic model “is dead” without strong export markets, Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics, told The Wall Street Journal.

China competition, inflation

China itself has proven to be a formidable competitor to Germany, especially in the auto industry, Germany’s biggest.

Europe, like the US, suffered a serious bout of inflation during the Covid pandemic, with prices rising to a 39-year high of 8.5% in 2022. That led the ECB to increase rates in 2022-23, pushing the key deposit facility rate to 4%. 

But inflation ebbed, dipping to 2.4% last month, not far from the central bank’s 2% target. The two-year decline pushed the central bank to begin cutting rates last June, three months before the Fed embarked on its rate-lowering.

What’s next for the ECB?

Now the ECB deposit facility rate stands at 2.75%, and investors anticipate a 25-basis point cut Thursday. The outlook from there is mixed. Many experts predict another two rate decreases before a pause. But some central bank officials are hesitant, with inflation still well above the ECB’s target

US tariffs are the big wild card. Donald Trump has threatened 25% tariffs against European Union goods, including the crucial auto sector. Tariffs are inflationary by definition. And if Trump follows through with all of his threatened hikes, Europeans (and most everyone else) would pay higher prices for a wide range of goods and services.

If inflation goes up, of course, that would tend to keep the ECB from easing further. But tariffs also could pull down Europe’s economic growth and even lead to recession. That would argue for lower rates from the ECB.

So it might be stuck between a rock and a hard place, forcing it to keep rates unchanged.