MNI INTERVIEW: Tariff Shock A Challenge To ECB's QT - Reichlin

There is a risk the European Central Bank will be forced to reduce the pace of its balance sheet runoff in order to safeguard the stability of the financial system in the wake of the U.S. tariff shock, its former director general of research Lucrezia Reichlin told MNI.

“In this difficult environment, there’s a risk of yields rising at the long end of the curve,” said Reichlin, adding that Germany’s recent announcement of a EUR500 billion infrastructure fund as part of a defence spending push has also removed a significant structural support for yields. “The ECB can't just rely on the convenience yield being low—as it has been, thanks in part to Germany’s investment plan. It should reconsider having a structural bond portfolio large enough to absorb shocks.”

Reichlin, now a professor at London Business School, said in an interview that she was “very worried” to hear plans for a fast reduction of the ECB’s balance sheet at its recent ECB Watchers conference, as it moves towards a world of less abundant reserves.

“Right now, yields remain calm, because money has left equities and flowed into bonds. But that could change, and once markets turn round, we might see tensions build up,” she said, adding that Italy in particular may struggle to meet new commitments to boost military spending given its limited fiscal space. Joint European debt would help mitigate such risks, she added. (See MNI: EU Defence Finance Not As Coordinated As Hoped - Official)

APRIL CUT

The ECB should cut interest rates again at its April meeting, as the euro area faces a hit to output which could put it in danger of recession, while inflation is close to target, Reichlin said. Policymakers also have the advantage of a resilient euro in the face of the U.S. tariff onslaught. (See MNI SOURCES: Tariffs Make ECB More Likely To Cut In April)

“The euro’s strength doesn’t come as a surprise — Trump’s policies have dented trust in the dollar, and Germany’s investment plan was a real boost for confidence, at least before markets turned,” Reichlin said.

While policymakers have expressed concern about the possible redirection of Chinese exports originally intended to the U.S. towards the EU, Reichlin said that this risk was limited and that the global shock this time was not disinflationary as in the wake of the collapse of Lehman Brothers.

“I don’t think we face much that much [disinflation]. The shock from 20 years ago is over,” Reichlin said, adding that inflation could be more volatile as the global economy reorganises in response to tariffs.

The European Union, which will inevitably retaliate against the U.S., should try to boost trade with Mercosur, Canada and especially China, she said. But trade talks with China should be more linked to specific strategic sectors, like electric vehicles or areas related to the green transition such as solar panels, rather than aimed at a large overall deal, she added. (See MNI: China To Hit Back Against US, Seek Europe Ties - Advisors)

The bloc needs to remain as cohesive as possible in order to boost its negotiating leverage with China, which has transformed itself in recent decades from a low-cost producer to a global leader in strategic sectors with which Europe, in Reichlin’s opinion, would be better off not competing directly. China is also the dominant player in Asian supply chains, she noted.