The trade war triggers inflationary pressures, and the European Central Bank may "cut interest rates for the last time" this week

Under the shadow of the trade war, the inflation game is about to differentiate the European Central Bank's decision-making body, and this week may be the European Central Bank's undisputed "last rate cut"!

On June 2, Bloomberg reported that over the past year, the European Central Bank's Governing Council has experienced almost no friction in seven rate cut decisions, and the eighth rate cut expected this Thursday (June 5) is anticipated to lower the deposit rate to 2%, but this harmonious situation is beginning to unravel.

The report pointed out that some officials hope 2% will be the bottom for interest rates, fearing the upcoming massive spending by European governments, while others hope for further rate cuts to support weak economic growth. Their key point of divergence lies in Trump's tariff policy and its chain reaction on Eurozone prices.

Katharine Neiss, Chief European Economist at PGIM Fixed Income, believes this means the European Central Bank must closely monitor the dual risks of inflation potentially being above or below the 2% target.

It is noteworthy that after this week's rate cut, investors still believe there will be one more rate cut.

On Inflation: Hawkish Warnings vs. Dovish Counterattacks

The report noted that in the short term, the inflation outlook appears mild: energy costs have plummeted, and the euro has strengthened since the U.S. first announced "reciprocal tariffs" in April. However, price trends will depend on possible retaliatory measures from the EU.

Data released by Eurostat on Tuesday (June 3) may show that the inflation rate has reached the target level of 2%.

In the long term, increased spending on defense and infrastructure in Europe, supply chain disruptions, and an aging workforce may all push inflationary pressures higher.

In the face of this complex situation, hawkish member of the European Central Bank's Executive Board, Isabel Schnabel, warned against further easing, believing that the European Central Bank "is in a favorable position to assess the potential future evolution of the economy" and can act as needed.

Klaas Knot, President of the Dutch Central Bank, and Joachim Nagel, President of the German Central Bank, also warned that the medium-term inflation outlook is unclear.

Holger Schmieding, Chief Economist at Berenberg, believes that the main threat in the future will be upward price pressures:

"The main reason is demographic changes and structural labor shortages. Many issues are currently masked by Trump's policies, but monetary policy is already taking effect, and there is no need to significantly increase stimulus now."

Some members of the European Central Bank's Governing Council are open to more vigorous action.

Pierre Wunsch, President of the Belgian Central Bank, stated that the European Central Bank may need to "slightly" support the economy to ensure inflation does not fall below the target.

Gediminas Simkus, President of the Lithuanian Central Bank, noted that the risk of downward price pressures is increasing.

Katharine Neiss, Chief European Economist at PGIM Fixed Income, stated that from a macro perspective, a rate cut is likely needed soon to support the economy through this uncertain period, but if fiscal and other policy levers are effective, rates may need to be raised further. However, Neiss also mentioned:

"Nevertheless, the European Central Bank must remain vigilant against the risk of returning to excessively low inflation, as experienced in the decade before 2020."

Will there be further rate cuts? Diverging market expectations

Investors expect another rate cut after this week's reduction. Analysts surveyed by Bloomberg seem more certain, predicting a cut in June and September, with a terminal rate of 1.75%. Bloomberg economist David Powell noted:

"The European Central Bank is almost certain to cut rates by another 25 basis points at the next meeting. The anti-inflation impact of U.S. tariffs, the latest wage growth data, and our forecasts all indicate that there is no longer a real inflation problem in the Eurozone."

However, some analysts anticipate a more significant easing. Gilles Moec, Chief Economist at AXA Group, stated that ongoing resistance from the U.S. and the risk of Chinese goods shifting to Europe point to milder inflation and rates potentially dropping to 1.25%. Moec warned:

"From now on, each rate cut will become more difficult, with increasing resistance, so it will be necessary to rely on data to persuade the Governing Council of the European Central Bank to go as far as I believe they ultimately must."