MNI INTERVIEW:Global Focus On Fiscal Strains- Ex ECB Economist
MNI (ROME) - Markets are likely to focus on fiscal policy strains in both the U.S. and the euro area this year, with central banks taking a patient approach to rate setting, though there is a risk that trade tariffs could “throw gasoline” back on inflation, former European Central Bank economist Riccardo Trezzi told MNI.
“In recent years, the focus was on monetary policy’s fight against inflation, and there was a disconnection between what monetary policy was doing and what fiscal policy was doing,” Trezzi told an MNI podcast. (Listen here or here)
“Now, fiscal policy, at least in some European countries, needs to do something to consolidate the budget because in some cases the deficit is definitely too high,” said Trezzi, who worked on the Federal Reserve Board’s inflation desk before taking on a similar role at the ECB.
With inflation in the eurozone now “more or less on target,” monetary policy can afford to be patient, focusing on risk assessment and navigating uncertainties, he noted.
Across the Atlantic, inflation dynamics are broadly similar, though prices have yet to reach target levels in the U.S. “There is a little bit more tension in the markets and a little question mark about whether the Fed is done or not,” he said, adding that the U.S. fiscal situation is clearly more challenging than in Europe.
“For the ECB, my expectation is wait and see. For the Fed, it’s wait and be ready to act.” (See MNI INTERVIEW: ECB Agrees On Gradual Cuts To Neutral - Centeno)
TARIFF RISKS
Anticipating concrete steps from U.S. President-elect Donald Trump’s trade policy is challenging, Trezzi said, as “he has said everything and the opposite.” But any escalation in trade tensions would pose inflation risks.
“If we go to this trade war, it would be like taking a tank of gasoline and putting it back on the inflation fire,” he said. (See MNI INTERVIEW: US 2025 Inflation Likely Higher-Ex-Fed's Koenig)
The inflationary impact of tariffs will depend on the extent to which consumers can substitute goods hit by trade measures, Trezzi said. In a worst-case scenario, U.S. inflation could rise by 1 to 1.5 percentage points due to tariffs, while the best-case outcome would add only a few tenths.
From a consumer perspective, there is unlikely to be a significant backlash if inflation remains at levels around 2.6%-2.7%, he said. “It really depends on exactly what they are trying to implement. Unfortunately, right now we still have very limited information,” he added.
Trezzi urged caution in assessing the potential impact of tariffs, recalling that during Trump’s first term, major announcements on trade measures targeting China ultimately resulted in limited actions, with only a few sectors, such as aluminium and washing machines, affected.
EUROPEAN OUTLOOK
Turning to the euro area, Trezzi warned that countries seeking to establish favourable terms with the Trump administration are unlikely to escape tariffs due to the constraints of Europe’s single market.
“Friendship or the direct channel between Meloni, Musk and Trump, I am not sure that it will be so effective [in avoiding tariffs] because you can’t really discriminate between both sides,” he said.
Should tariffs be imposed on European imports, Italy and Germany would be among the most affected countries due to their export-driven economies, he noted.
Tariff threats could be part of a negotiation tactic aimed at reducing the U.S. trade deficit, and European capitals should work to engage Trump diplomatically to prevent escalation.
“I would call the new administration and say, ‘What are you trying to achieve here? 30% on digital spending, 3.5% on defence spending…’,” he said.