By Paul Hannon

The European Central Bank is set to follow global peers and lower its key interest rate Thursday to help cushion the eurozone economy against the uncertainty unleashed by President Trump's barrage of tariff hikes.

The case for a cut has been bolstered by the surprising strength of the euro in the wake of the April 2 tariff announcements. In gaming out the possible impact of tariffs, policymakers had expected a weakening currency to push prices of imports higher. But that hasn't happened.

While Trump subsequently suspended the bulk of his tariff agenda for 90 days, ECB policymakers will want to keep their options open. So the language they use to describe their stance after a cut in the key rate to 2.25% is likely to be unchanged.

"This is not the time to call an end to the easing cycle," economists at Morgan Stanley wrote in a note to clients. "We expect the statement to describe rates as still being restrictive, in line with the March communication."

While there are ways in which U.S. tariffs can lead to higher prices in other countries, in practice central banks appear to be more concerned by the impact on economic growth, and the inflation outlook over the medium-term.

The most immediate boost to eurozone inflation would come through retaliation against the U.S., which would raise the prices of goods imported from the world's largest economy. However, the retaliatory moves announced by the European Union to date appear fairly modest, and have also been suspended for three months.

While retaliation is unlikely to boost inflation much, the feared weakening of the euro hasn't been a factor at all. Typically, economists would expect the currency of the country imposing tariffs to gain against the currencies of the targeted countries, since weaker demand for the tariffed products should weaken demand for the currency in which they are sold.

Instead, the U.S. dollar has weakened since the April 2 announcement, a sign that some investors are retreating from U.S. assets once considered safe. Bank of France Governor Francois Villeroy de Galhau described that as "probably the biggest surprise in the market reaction."

"This is a factor in controlling inflation," he said.

Other market developments will also lower eurozone inflation if they are sustained. Oil and natural gas prices have fallen sharply since April 2 in anticipation of a global economic slowdown. Taken together, those moves could significantly lower eurozone inflation this year.

At the same time, ECB policymakers will be expecting trade diversion to lower the prices of imported goods. While Trump has suspended some of his tariff increases, he has doubled down on imports from China.

Chinese businesses will likely try to find customers elsewhere, and lower their prices to do so. Even if they exercise some restraint following talks between European Commission President Ursula von der Leyen and China's Premier Li Qiang, that is likely to cool eurozone inflation.

But while the immediate inflationary impact of the tariff war is set to prove less significant than feared, it will likely have a negative impact on eurozone growth.

Some of the tariffs may have been suspended, but high levels of uncertainty remain, likely making households and businesses reluctant to commit to big outlays in the coming months.

These are the considerations that have already persuaded the central banks of India, New Zealand and the Philippines to lower their key interest rates in the wake of the April 2 announcement. Others will surely follow.

Write to Paul Hannon at paul.hannon@wsj.com

(END) Dow Jones Newswires

April 14, 2025 02:00 ET (06:00 GMT)

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