Undershooting Ahead

We think the ECB will continue to provide reassurance this Thursday beyond “merely” delivering another widely expected 25-bp cut. Bringing the policy rate to 2% takes a particular significance since this level is often seen as the “neutral rate”. Yet, we think the ECB, without providing explicit forward guidance, will make it clear that it can “break” this level and descend into accommodative territory without a too painful internal discussion. The new macroeconomic projections should help. Indeed, relative to the March batch, the Eurosystem’s economists will take on board the appreciation in the euro exchange rate and the further decline in oil prices, which should raise the probability that inflation could undershoot the ECB’s target for a longer share of the forecasting horizon than in March. The picture for the real economy is unlikely to be rosy, even if the German fiscal push could lift the GDP projection somewhat towards the end of the projections. 

Still, the pace and magnitude of such cuts will largely depend on the outcome of the EU-US trade talks – which is a strong reason why providing explicit forward guidance is difficult now. Uncertainty on this front has risen further after a decision by the US Court of International Trade invalidating a lot of the tariffs imposed by executive orders (those taken in retaliation against drug and people smuggling, and the “reciprocal tariffs). The Court’s decision has for now been stayed by the Federal Circuit Court, and the case may have to go all the way to the Supreme Court. We explore the case in some detail as it raises some fundamental issues, notably on the separation of power in the US, which has brought together a surprising alliance of Democrats, traditional Republicans and Libertarians. We note however that the US President would still have at his disposal a vast arsenal of tariffs to use, should the Supreme Court side with the CIT. A risk is that EU negotiators, instead of dealing with one, major tariff on most products, end up having to respond to a myriad of sector-specific tariffs, which could make the discussion even more complex.