The European Central Bank is widely expected to lower interest rates at its meeting next week, but investors will be more interested in any clues on what an escalating global trade war means for monetary policy later in the year.
Markets have moved to price in a faster pace of rate cuts as Donald Trump’s tariff blitz intensified. Even after announcing a 90-day pause on tariffs for countries other than China, traders are betting on three quarter-point reductions this year with the first coming on Thursday.
Greece’s central bank governor Yannis Stournaras — a member of the ECB’s rate-setting council — warned in an interview with the Financial Times this week that a trade war would expose the currency bloc to a large “negative demand shock” that would create significant deflationary pressures.
“Fears about a global trade war have upended hopes that the Euro area was on the cusp of a durable economic recovery in 2025,” said Michael Krautzberger, global chief investment office for fixed income at Allianz Global Investors. “The optimism from the recently announced German fiscal stimulus has quickly evaporated and been replaced by fears of a looming negative demand shock for the region.”
Krautzberger added that he expected the ECB to be “sensitive to the downside growth risks facing the region, supporting its bias to ease policy further in the coming months”.
Despite the expectation of rate cuts, the euro shot to a three-year high against the dollar this week as investors ditched US assets. Tommy Stubbington
Will the dollar continue to tumble?
The pressure on the dollar is likely to continue as uncertainty surrounding Trump’s policies undermines confidence in the world’s reserve currency, investors warn.
The greenback has plunged to three-year lows against the euro and has dropped 4 per cent against a basket of major currencies since the “liberation day” tariff announcements on April 2.
The dollar index has also dropped below a key level of 100 for the first time since July 2023.
Goldman Sachs predicted the currency, which has been weakening since the US president’s inauguration in January, could tumble further as Trump’s actions unsettle the markets.
The White House was “eroding the exorbitant privilege long-enjoyed by US assets, and that is weighing on US asset returns and the dollar”, said Kamakshya Trivedi, head of global foreign exchange and rates research at the bank.
Asset managers fear the reputation of the US financial system is being tested by Trump’s aggressive trade policies.
The recent slide could be the start of a much broader shift of capital away from the US, according to John Butler, macro strategist at Wellington Management, which manages more than $1tn in client assets.
“From a global investor perspective, such a scenario would imply that the US no longer offers the same protection against rising inflation,” Butler said.
“If the Fed keeps rates elevated to combat above-target inflation, it will face increased political pressure,” he added. “[This] could undermine its credibility, which again is a negative for investors.” Alan Livsey
Is UK inflation still falling?
Investors will closely monitor UK inflation and wage growth data this week to assess the price pressures faced by the Bank of England as it prepares to lower interest rates.
The annual inflation rate for March, released on Wednesday, is expected to fall to 2.7 per cent from 2.8 per cent in February before it starts to climb again, peaking in September.
Falling fuel prices and distortions from last year’s early Easter are expected the be the main factors depressing the rate, according to economists.
The Bank of England forecast in February that inflation will rise to 3.7 per cent by the middle of the year, but lower energy prices following the US tariff blitz might change those expectations.
“The US tariff hikes have far-reaching consequences, which should ease the Bank of England’s worries about potential persistence in inflation,” Sandra Horsfield, economist at Investec, said.
Weaker global demand, the possibility of lower import prices as Chinese goods planned for the US are diverted to Europe as well as lower energy costs will all ease pressure on inflation, she added.
This means the March inflation numbers “may carry less weight in the Monetary Policy Committee’s assessment than in other, more normal, times”, she explained.
The labour market data published on Tuesday is expected to show “payroll jobs falling, unemployment ticking up, but wage gains staying strong”, according to Rob Wood, economist at the consultancy Pantheon Macroeconomics.
In normal times, this combination would support policymakers’ guidance for “gradual and careful” rate cuts, but the “ructions from President Trump’s tariffs will probably make the MPC more dovish for now”, he added. Valentina Romei
