Central Bank Maintains Interest Rates; Worry Over US Tariffs Persists
In the midst of an escalating trade dispute between the European Union (EU) and the United States, economists and policymakers are bracing for potential economic and inflationary impacts on the Eurozone.
The trade conflict, fuelled by tariffs and retaliations, is expected to dampen the Eurozone's economic growth while pushing up inflation. This complex economic landscape has prompted the European Central Bank (ECB) to exercise caution, as it navigates the delicate balance between growth and price stability.
Reduced GDP growth is a significant concern, as retaliatory tariffs disrupt trade flows. For instance, US tariffs targeting $2.3 trillion in goods imports, with the EU imposing retaliatory tariffs on $330 billion worth of US exports, create market uncertainties and reduce export volumes. This can lower Eurozone GDP growth due to less demand for its goods in the US and increased costs of imported inputs.
Supply chain disruptions and increased production costs are also looming threats. Rising tariffs on intermediate goods and capital equipment raise production costs for Eurozone companies reliant on US imports. This can reduce competitiveness and investment, slowing economic expansion.
Trade patterns may shift as businesses seek alternative markets or reconfigure supply chains to avoid tariffs, leading to inefficiencies or increased costs that depress economic growth in the short term.
Inflationary pressures are also on the rise, as tariffs act like taxes on imports, leading to more expensive American goods and inputs. This cost increase often passes through to consumer prices, increasing inflationary pressures in the Eurozone. If the trade dispute results in prolonged tariff escalations or trade barriers, inflation in the Eurozone is likely to remain elevated, as import cost increases sustain.
The ECB, aware of these challenges, has left interest rates unchanged, with the deposit rate remaining at 2.0 percent. In June, inflation in the Eurozone stood at 2.0 percent, according to Eurostat, significantly lower than the ECB's target. The ECB aims to maintain stable prices, as higher inflation reduces purchasing power.
Looking ahead, the ECB forecasts inflation in the Eurozone this year to be 2.0 percent, with a potential significant undershoot in 2026 at 1.6 percent. The ECB's next interest rate decision is scheduled for September, and the bank has expressed concern that inflation could fall below the ECB's target due to the strong euro.
The strong euro, making imports into Europe cheaper, eases price pressure, but the ECB is also mindful of the trade dispute's unpredictable impact on the economy and inflation. The ECB has paused to gain time until its next interest rate decision, seeking to avoid persistently falling prices, as this could discourage investments and slow economic growth.
The ongoing uncertainty around tariff policies and potential further retaliations means these impacts could intensify if the dispute escalates or persists longer-term. The ECB's caution is due to the trade dispute between the EU and the USA under President Donald Trump, and the impact of the imposed and threatened high tariffs on the economy and inflation is difficult to assess.
[1] IMF, "World Economic Outlook Update, July 2018," International Monetary Fund, 2018. [2] European Central Bank, "Box 2: The global economy and the euro area outlook," Economic Bulletin, Issue 6, 2018. [3] European Central Bank, "Box 3: The impact of trade tensions on the euro area," Economic Bulletin, Issue 3, 2019. [4] European Central Bank, "Box 4: The global economy and the euro area outlook," Economic Bulletin, Issue 5, 2019.
The escalating trade dispute between the EU and the US is causing significant concerns in the general-news arena, as economists and policymakers fear its potential negative effects on the Eurozone's economy and inflation. The ECB, bracing for potential market uncertainties, is keeping a close watch on the business sector, particularly Eurozone companies relying on US imports, as increased tariffs on intermediate goods and capital equipment could increase their production costs and reduce competitiveness, impacting the sports and finance sectors. The ECB's caution is due to the prolonged trade dispute, which is affecting the politics sphere as well.
