ECB cuts rates to 2.25% as Trump tariffs darken eurozone outlook

The European Central Bank lowered its deposit rate by a quarter of a percentage point to 2.25% on Thursday, the third cut this year and the seventh since the tightening cycle peaked at 4% in September 2024. The decision, widely expected by economists, came as the 20-member euro area confronts a sudden escalation in trade tensions triggered by Donald Trump's tariff programme.

Christine Lagarde, the ECB president, told journalists in Frankfurt that US tariffs on EU goods had jumped from an average of 3% to 13% since the measures took effect earlier this month. "The major escalation in global trade tensions and the associated uncertainty will likely lower euro area growth by dampening exports," she said, adding that they may "drag down investment and consumption". The governing council's accompanying statement was blunt: increased uncertainty is likely to reduce confidence among households and firms, and volatile market reactions may further weigh on the outlook.

The tariff shock and its transmission

The Trump administration has imposed a 10% baseline tariff on all EU imports, with a further 10% suspended until July pending negotiations. On top of that, sectoral tariffs of 25% already apply to steel, aluminium and cars, while pharmaceuticals and electronics have been threatened with similar treatment. For an export-dependent bloc, the cumulative effect is material. The ECB's own analysis suggests the measures will shave measurable fractions off GDP growth this year and next, though precise estimates vary.

Lagarde was unusually direct about the policy dilemma. "Anybody in this room who thinks that we are in a shock-free world, I would suggest [they] have their head examined," she said, dismissing the concept of a neutral interest rate as a theoretical construct that only works in the absence of shocks. The remark underscored how far the policy conversation has shifted from calibrating restriction to navigating a sequence of external blows, pandemic, energy crisis, now trade war.

Inflation dynamics create room to move

The cut was enabled by a sustained improvement in inflation data. Eurostat reported on Wednesday that headline inflation in the eurozone eased to 2.2% in March from 2.3% in February, while core inflation, excluding energy and food, fell to 2.4% from 2.6%. Services inflation, the stickiest component through 2023 and 2024, has eased markedly in recent months. Wage growth is moderating, and where it remains elevated, companies are absorbing costs through thinner margins rather than passing them on.

The ECB said most measures of underlying inflation now suggest price pressures will "settle at around the 2% medium-term target on a sustained basis". That phrasing matters: it signals the governing council is comfortable that the disinflation process is sufficiently entrenched to tolerate easier policy even as a negative supply shock from tariffs risks pushing up import prices.

Guidance deliberately absent

Lagarde declined to signal the pace or endpoint of further easing. The neutral rate, the level that neither stimulates nor restrains, is unknowable in the current environment, she argued, because the transmission of tariffs through trade volumes, supply chains, confidence and financial conditions is impossible to model with precision. The governing council's statement retained its standard formulation that policy will remain "sufficiently restrictive for as long as necessary" but added that future decisions will "ensure that monetary policy becomes meaningfully less restrictive" as the disinflation process continues.

That studied ambiguity left markets to read between the lines. Money markets price roughly 60 basis points of further cuts by the end of 2025, implying two more quarter-point moves after Thursday. Mark Wall, chief European economist at Deutsche Bank, said the emphasis on a tariff shock "implied an openness to further monetary easing", assuming the trade shock persisted, and was "borne out in the data". His team expects the deposit rate to reach 1.5% by December.

Diverging paths across the Atlantic

The contrast with the Federal Reserve is stark. The Fed held rates steady at its March meeting, and Jerome Powell told the Economic Club of Chicago on Wednesday that US tariffs on roughly 60 countries would increase domestic prices and reduce hiring. He acknowledged it was unclear whether the overall impact would require higher rates to combat inflation or lower rates to support growth, a statement that triggered a sharp sell-off in US equities. Trump responded on his Truth Social platform that Powell was "always too late and wrong" and that his "termination cannot come fast enough".

The Bank of England is expected to follow the ECB's lead. Investors price a quarter-point cut at the May meeting and two more before year-end, taking Bank Rate from 4.5% to 3.75%. The BoE's Monetary Policy Committee meets next on 8 May, by which time the first hard data on UK-US trade flows under the new regime will be available.

IMF warns of systemic erosion

Speaking ahead of the IMF-World Bank spring meetings in Washington, Kristalina Georgieva said the latest World Economic Outlook would include "notable markdowns, but not recession". She described trade tensions as "like a pot that was bubbling for a long time and is now boiling over", adding that "to a large extent, what we see is the result of an erosion of trust, trust in the international system, and trust between countries." The IMF's baseline still sees positive global growth in 2025, but the distribution of risk has shifted decisively to the downside.

What the data will show next

The next six weeks will be decisive. Eurozone flash PMIs for April, due on 23 April, will give the first real-time glimpse of how manufacturing and services orders are reacting to the tariff announcements. German industrial production and export figures for March, released by Destatis in early May, will show whether the pre-tariff front-loading of shipments that buoyed late-2024 data has reversed. The ECB's own quarterly Survey of Professional Forecasters, due 12 May, will reveal whether private-sector economists have marked down their 2025 and 2026 growth projections in line with the governing council's assessment.