By Francesco Canepa and Balazs Koranyi
FRANKFURT (Reuters) - The European Central Bank was set to keep interest rates on hold on Thursday, pausing after seven straight cuts as it waited for the fog surrounding Europe's trade relations with the United States to clear.
The ECB has halved its policy rate from 4% to 2% in the space of just one year after taming a surge in prices that followed the end of the COVID-19 pandemic and Russia's invasion of Ukraine.
With inflation now back at its 2% goal and expected
to stay there, euro zone central bankers were likely to stay put this week and observe what kind of tariffs President Donald Trump's U.S. administration would impose on the European Union after an August 1 deadline for talks.
"The ECB is widely expected to keep policy on hold this week, as uncertainty prevails with no trade deal yet on the horizon between the U.S. and EU," Christophe Boucher, chief investment officer at ABN AMRO Investment Solutions, said.
The tense and unpredictable trade talks between Washington and Brussels have made policy-making difficult.
Trump's threat to impose a 30% duty on EU goods exported to the United States - a steeper tariff than the ECB had anticipated under even the most negative of three scenarios it released last month - has forced President Christine Lagarde and her colleagues on the ECB's Governing Council to contemplate lower outcomes for growth and inflation.
However, two diplomats said on Wednesday the EU and the U.S. were heading towards a deal that would result in a broad tariff of 15% applying to EU goods.
"Even in the case of a benign outcome (i.e. U.S. tariffs around 10%) we still see scope for further easing as the disinflation process broadens," MUFG's Europe economist Henry Cook said.
Investors generally expect one more ECB rate cut by the end of the year, most likely in December.
Among the deals that have been struck so far and could serve as a template for the EU, Japan negotiated a 15% tariff rate, Indonesia 20% and Britain, which runs a trade deficit with the United States, 10%.
"The key point is that tariffs look likely to be higher and more varied across countries than the 10% flat baseline that many had assumed would be the end-point of tariff negotiations," BNP Paribas's head of developed markets economics Paul Hollingsworth said.
The ECB assumes that U.S. tariffs will push down growth and, if there is no EU retaliation, inflation over the medium term.
The euro zone economy is already barely growing and companies, while still optimistic about an upturn ahead, are starting to feel the pinch from tariffs on their profits.
"The risks are still weighted towards weaker growth outcomes for Europe," economists at Deutsche Bank wrote. "This in turn points to disinflationary risk, particularly if a trade shock were to become a labour market shock."
On the other hand, banks have seen rising loan demand and policy uncertainty has not yet translated into an economic or market downturn.
After a short-lived selloff in April investors have taken the trade turmoil in their stride, with European equity indices close to new highs also thanks to Germany's newly found appetite for spending.
In fact, erratic policy-making in the United States, including Trump's relentless criticism of the Federal Reserve, has lured foreign investors to euro zone assets, briefly pushing the euro to the highest level against the dollar since September 2021 at $1.1829 earlier this month.
ECB board member and outspoken hawk Isabel Schnabel even said the central bank should watch out for price hikes caused by tariffs and the bar for further cuts was "very high".
But the euro's appreciation has unnerved other policymakers, who fear a stronger currency would make European exports less competitive and contribute to pushing down inflation.
"On that front, we would expect Christine Lagarde to strike a reassuring tone, reminding people that the ECB does not target exchange rates but that any resulting downward pressure on inflation will be addressed, if necessary," Julien Lafargue, chief market strategist at Barclays Private Bank, said.
(Reporting By Francesco Canepa; Editing by Toby Chopra)
