Tariff uncertainty and euro appreciation push ECB to pause rate cuts

The European Central Bank (ECB) is meeting this Wednesday and Thursday and is almost certain to leave interest rates unchanged, underscoring the ongoing uncertainty surrounding trade. The euro has appreciated significantly against the dollar in recent weeks, which risks leaving the monetary authority in a less comfortable position, something acknowledged by the bank's own officials, but changes are not expected for now.

With eight consecutive cuts behind us and the key rate at 2%, interest rates in the eurozone are in line with the most recent inflation reading, which also coincides with the ECB's medium-term price objective. Given this scenario, the consensus among analysts and investors is that the single currency's downward cycle is over, meaning the July meeting will not bring any rate changes.

There's still the possibility of another cut, but only in September. For Martin Wolfburg, senior economist at Generali Investments, weak growth, the disinflationary force created by the euro's appreciation, and downside risks will lead the ECB to cut once again as "insurance" against this trend.

Ebury agrees with this view, adding that President Lagarde, "who has a propensity to provide very little forward-looking information, has even less incentive to signal the way forward."

On the other hand, with the EU on the brink of a trade war with the US, the uncertainty so often highlighted by the ECB president is returning with a vengeance. The deadline to reach an agreement with transatlantic partners is approaching (next week, August 1st), and there are signs that, if no agreement is reached, Brussels will retaliate—which risks further pressure on prices and inflation.

"Speculation about a no-deal EU-US scenario is growing. There are reports that some countries are calling for retaliatory measures as they see the chances of an agreement diminishing," write analysts at ING bank, although they do not foresee a new rally for the euro against the dollar.

The euro has appreciated more than 12% against the US dollar since the beginning of the year and is currently at 1.17, despite a slight correction in the last session. However, on a trade-flow-weighted average, the single currency is well above this value compared to the dollar, aiming for something closer to 1.60.

ECB Vice President Luis de Guindos acknowledged at the annual meeting in Sintra that a euro above $1.20 would make the scenario "more complicated," echoing concerns from several national central bank governors and investors. On the other hand, the influence of Fed policy on the euro is much greater than the reverse, leaving the ECB more vulnerable to US monetary decisions.