September interest rate cut expectations plummet! Lagarde warns: If US-EU trade frictions escalate, it will exert downward pressure on inflation

On Thursday, the European Central Bank (ECB) kept interest rates unchanged, marking the first time in over a year that it pressed the "pause button" on rate cuts. At the subsequent monetary policy press conference, the ECB maintained its cautious stance while remaining highly attentive to uncertainties that may arise from the global trade situation.

ECB President Christine Lagarde emphasized that inflation is currently moving towards the mid-term target of 2%, but there remains significant uncertainty regarding the outlook, particularly concerning risks related to U.S.-EU tariff negotiations. Lagarde mentioned that if trade frictions between the U.S. and Europe escalate and tariff barriers rise, it could exert downward pressure on inflation in the Eurozone.

According to a previous article by Wall Street Insight, media reports indicated that the agreed-upon tariff levels between the U.S. and Europe are similar to those reached in the recent U.S.-Japan agreement, which includes existing tariffs, meaning that the automotive tariffs faced by the EU would drop to 15%. According to CCTV News, Trump announced on July 12 that a 30% tariff would be imposed on goods imported from the EU starting August 1.

After the press conference, the probability of a rate cut in September dropped significantly from 40% before the decision to 28%; the probability for December was 72%, down from earlier predictions of over 90%.

ECB "is in a good place"

The ECB's decision to maintain the main interest rates aligns with market expectations.

At the press conference, Lagarde reiterated her previous statement, saying that "the ECB is in a good place" because several forward-looking indicators show that inflation is stabilizing towards the 2% mid-term target.

Lagarde pointed out that several potential inflation indicators currently show that price pressures "are generally in line with our targets." However, she also acknowledged that "the assessment of future inflation is more uncertain than before."

She noted that current wage growth is "moving in the right direction," and corporate profits have somewhat cushioned the cost pressures from rising wages, while economic growth is "continuing to unfold in a relatively favorable environment."

Tariff risks may exert downward pressure on inflation, exchange rate fluctuations enter policy focus

Notably, Lagarde mentioned that if trade frictions between the U.S. and Europe escalate and tariff barriers rise, it could exert downward pressure on inflation through two pathways: on one hand, suppressing European export demand, and on the other hand, causing overcapacity countries to redirect goods to the European market, thereby depressing local prices.

Additionally, trade tensions may also exacerbate volatility in financial markets, increase risk aversion, and further suppress domestic demand.

Despite the recent strengthening of the euro, Lagarde reiterated that the ECB "does not target the exchange rate as a policy goal," but will "incorporate its impact into inflation forecasts."

She stated that there are currently no signs that the appreciation of the euro has posed a challenge to policy, indicating that the ECB is unlikely to take additional action in response to exchange rate fluctuations in the short term.

Calling for structural reforms from governments, emphasizing policy coordination

In addition to interest rate policy, Lagarde once again urged governments to "urgently" promote structural reforms and pointed out that in the current environment of relatively loose fiscal policy, it is essential to enhance economic resilience by improving productivity and stimulating investment She bluntly stated, "The European Central Bank is now more eager than ever to see the advancement of structural policies."

September Rate Cut Expectations Plummet

As Lagarde released a "steady yet cautious" policy signal, traders' expectations for a rate cut this year have decreased. European interest rate futures show:

• After the press conference, the probability of a rate cut in September dropped significantly from 40% before the decision to 28%; the probability for December is 72%, down from earlier predictions of over 90%.
• For the entire year, only a maximum of 20 basis points of rate cut space is accounted for, far below previous expectations.

It is noteworthy that when Lagarde was asked about the prospect of raising interest rates in the absence of trade uncertainty, she did not dismiss the idea but stated that easing trade tensions would certainly reduce the uncertainty faced by consumers and businesses. "The future will tell us" how its impact will unfold.

Mark Wall, Chief European Economist at Deutsche Bank, stated that while we are still in an observation period, if trade uncertainty eases, combined with enhanced economic resilience and ongoing fiscal stimulus, inflation expectations may be pushed higher in the future, and the market will shift from discussing "the last rate cut" to "the timing of the first rate hike."

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