MNI SOURCES: ECB Cuts Consensus, But Trump, Fiscal Risks Ahead
MNI (LONDON) - There is broad consensus among officials that the European Central Bank will continue cutting the deposit rate in 25-basis-point increments towards about 2% this year, but they are increasingly wary of risks emanating from both the U.S. and Europe’s own fiscal policy to which monetary policy might struggle to respond, Eurosystem sources told MNI.
The next two Governing Council meetings, concluding on Jan 30 and March 6, are both set for cuts, with sources emphasising that the uncertain environment requires a gradual approach to monetary easing, and that there is for the moment little prospect of any acceleration to a reduction of 50bp.
Policymakers are divided over the timing of a potential third cut, with some pointing to April and others to June. But it is possible that the ECB could cut consecutively to reach 2.25% or 2%, a level around its estimates of the nominal neutral rate, they said.
“I think January is a sure cut and March is almost a sure cut as well. But in March there will be much more information on the new global landscape to be reflected in the projection exercise. That is going to be the key to continue on our way,” one source said.
But the impact of any trade war started by U.S. President Donald Trump, which could further depress European growth as well as possibly feeding inflation, together with the spillovers from expansive U.S. fiscal policy, are complicating the outlook. This comes as European fiscal weakness raises the danger of a rise in bond yields, which would weaken the transmission of monetary policy.
U.S. INFLATION
“We should not underestimate the impact of U.S. inflation on Europe. It may affect us more than people think,” one senior Eurosystem official said, adding that in addition to the inflationary impact of tariffs a depreciating euro could push up prices of energy and other goods as expectations for Federal Reserve easing recede.
“I would advise being very gradual in our down cycle, see what cards are being played and follow through. Unfortunately we have no idea what Trump is going to
propose", the source said, adding that the January meeting will be very much focused on Trump. (See MNI INTERVIEW2: Trump Stagflationary For EZ-ECB's Wunsch)
Trump’s policies may expose deep weaknesses in the European economy, another said, adding that he was worried that they might have a serious impact on GDP, which the ECB projects to grow by only 1.1% this year.
“My greatest concern is that Trumponomics 2.0 is a greater threat to output than to prices. But I'm not sure lowering rates quicker will help. The problems are far deeper than that and we need greater political will from the member states to overcome structural challenges,” the official said.
WEAKER EURO
A weaker euro is unlikely to fully compensate for the hit to European exporters’ competitiveness from tariffs, but, as a channel of imported inflation, there is a risk it could reduce the ECB’s room for easing, other sources said. (See MNI: Energy Little Threat To ECB’s Inflation Target- Officials)
“We will be very attentive to what we see in the United States and the Fed. Because it may condition our action a little, as it is not desirable to distance ourselves too far,” one official said.
Another source of risk comes from closer to home, with political volatility in France and Germany further highlighting fiscal weakness throughout the bloc.
“Fiscal is an issue. Consolidation plans are elusive in many locales and there only seems to exist support for fiscal responsibility in those countries that suffered the most during 2009-12, Greece and Portugal, because of the memory of what a sovereign crisis can do to you,” another source said.
“Spreads’ rise is too muted to impress policymakers, but sufficient to neutralise the transmission of monetary easing to visible prices such as mortgage rates. This is a sort of automatic correction for the excessively easy fiscal stance… but loose fiscal-tight-money is a bad mix,” the source said.
An ECB spokesperson declined to comment.