MNI SOURCES: ECB Heads For June Cut, But Debate To Be Lively

While there is broad consensus among European Central Bank policymakers that U.S. tariffs will exert downward pressure on inflation for the short term at least, hawks warn that June’s meeting will see lively debate despite a general expectation that it will result in a cut, Eurosystem sources told MNI.

Uncertainty surrounds the longer-term effects of trade restrictions as the world economy reconfigures, including whether the euro’s recent appreciation will persist and how a flow of Chinese imports diverted from the U.S. will influence inflation in the euro area, officials said. Hawkish voices argue that a further 25-basis-point cut in the deposit rate, taking it to 2% in June, could limit the ECB’s policy flexibility, but more dovish officials argue that given the situation as it now seems multiple cuts may still be warranted.

“We have a limited margin to move now,” one official said, “In the short term there is no doubt that trade disputes and tariffs will be deflationary, but in the longer term I don’t know. Most of the elements that could push prices down can quickly disappear.”

Rates should remain near the neutral level, said the source, though a majority of officials, including President Christine Lagarde, consider that the concept of neutral is of limited use now that rates are low and at a time of uncertainty and global shocks.

A source at another national central bank dismissed concerns about any trade-driven upsurge in prices.

“It easy to anticipate that there will be further cuts down the road in 2025 if things do not improve quickly. The international context, including euro appreciation, gives us space to cut without being worried about inflation,” said another source at a national central bank. (See MNI INTERVIEW: ECB To Stick To QT Despite Turmoil - Papadia)

LIKELY LANDING ZONE

The 2% level remains the most likely landing zone for the ECB’s deposit rate, sources said, though one said the risk has shifted towards a potential floor of 1.75% in the wake of the U.S.’s “Liberation Day” tariffs.

“A new cut in June can almost be taken for granted, but beyond that, it seems difficult to me. I'm not sure it's positive to venture further cuts in such an uncertain and ever-changing context,” another official said.

Should June’s staff projections reveal a further deterioration in the growth outlook, the ECB could begin to explore whether to guide policy into accommodative territory, sources said. However, the Governing Council as a whole is dropping references to the so-called "neutral rate", with the discussion instead shifting towards identifying levels at which interest rates are “appropriate” for achieving the inflation target.

“Again, last week, there was zero debate on where neutral is and agreement on full optionality, including on what the terminal rate is (not necessarily the unobservable neutral rate),” one source said, speaking after the IMF-World Bank’s spring meetings in Washington. Another official agreed, adding that the ECB is deliberately trying to move away from using neutral as a conceptual framework.

The debate is instead likely to focus on how best to calibrate monetary policy in line with market expectations and the medium-term macroeconomic outlook.

GLOBAL UNCERTAINTY

Officials observed that sentiment shifted rapidly after April’s meeting, though it remains unclear whether the reversal in U.S. President Donald Trump’s approach—or swift changes in macroeconomic trends such as a weakening dollar or persistent Chinese overcapacity—could once again reshape the outlook. (See MNI: EU Countries See US Shift In Tone But Trade Deal Unlikely)

Two sources said the tone of public communications by Governing Council members following the April meeting may have conveyed greater confidence than the evolving global outlook warrants.

“The real story for June is whether radical uncertainty remains and whether it justifies (1) risk-management and (2) unwillingness to deviate from what markets expect,” said one official, in an email.

An ECB spokesperson declined to coment.