Two (Wrong) Reasons Why the ECB May Decide Not to Cut Rates

At its next meeting on 5 June, the European Central Bank is expected to cut interest rates by another 25 basis points. Financial markets currently anticipate this outcome with high probability (85%). 

However, this probability has declined in recent days, and one cannot entirely rule out the possibility that the ECB may ultimately reconsider. 

There are essentially two reasons that could justify such a decision. 

The first would be a rapid reversal in the international outlook, following a truce in the trade war initiated by the Trump Administration, which could reignite economic growth. 

There have been some signs pointing in this direction, beginning with the agreement reached with the United Kingdom and the 90-day suspension of tariffs on China. 

Markets have responded positively to this news, with a modest recovery in equity prices, a slight strengthening of the dollar, and a rise in long-term interest rates. Over the past ten days, yields on 10-year US Treasuries and German Bunds have increased by around 20 basis points. 

Nonetheless, it seems unlikely that these positive signals will be sufficient to offset the uncertainty that has accumulated since the onset of the tariff war. 

The terms of the agreements announced by the US Administration are still unclear. While the extreme tariff increases threatened during “Liberation Day” have been avoided, tariffs will still rise — by at least 10%. 

This will inevitably hamper trade and disrupt global value chains. 

In the short term, uncertainty weighs negatively on consumption and investment, as confirmed by the latest IMF forecasts, which have downgraded both growth and inflation projections for Europe over the next two years. The ECB itself has recently revised its own forecasts in the same direction. 

In summary, there does not yet appear to be sufficient evidence to justify a reversal of the decision to further ease monetary policy in the coming weeks. 

The alternative hypothesis is that the ECB is shifting its monetary strategy — basing its decisions less on short-term macroeconomic data and forecasts, which are highly uncertain, and more on medium- to long-term structural factors. 

This hypothesis appears to be supported by recent public statements from some members of the Executive Board. 

Such a change in strategy could be justified by various considerations. First, central bank decisions — such as interest rate reductions — typically take time to impact the economy. Focusing on the short term would therefore be futile, and potentially even harmful.  

Moreover, policy rates have now reached a level — 2.25% for the deposit facility — which can be considered broadly consistent with the underlying conditions of the European economy. 

Finally, inflationary risks are likely to rise in the long run, mainly for two reasons. 

The first is European fiscal policy, particularly in Germany, which is set to become far more expansionary in the coming years due to significant spending commitments, beginning with defence. 

The second concerns the process of deglobalisation triggered by the trade war, which will increase the cost of international trade and feed through to consumer prices. 

According to this new strategy, the ECB should hold rates at current levels and refrain from further cuts. In other words, the markets are wrong in pricing a rate cut in June. 

These arguments may be debated on their merits. But even more questionable is the method. 

It is legitimate to ask whether this apparent paradigm shift represents an official ECB position, or whether it is merely the personal reflection of one or more members of the Executive Board. 

In the latter case, it is even more legitimate to ask why such views are being aired publicly before undergoing internal analysis and collective scrutiny. 

The urge to express opinions publicly — not so much on the underlying economic situation as on the policy direction that monetary policy should take in the coming weeks and months — creates confusion in financial markets and risks undermining the credibility not only of the speakers, but of the central bank itself. 

This is especially true when final decisions — possibly adopted unanimously — end up going in the opposite direction of what was publicly suggested. 

A first version of this article was published in the Italian daily Il Foglio