Under the impact of the trade war, the European Central Bank vows to carry out easing to the end!

Source: Wall Street Insights

Under the impact of tariffs, the monetary policy of the European Central Bank (ECB) has clearly shifted towards a dovish stance, and the market expects that interest rates will continue to be cut in June and beyond.

Recently, both Citibank and Bank of America Merrill Lynch released reports on the latest policy meeting of the European Central Bank. Both institutions believe that the ECB's policy stance has shifted to a dovish one, and it is expected that further interest rate cuts will be made to address the downside risks to economic growth and inflation.

Citibank believes that the ECB not only cut interest rates by 25 basis points as expected, but more importantly, confirmed that the policy discussion has shifted from "whether monetary policy is restrictive" to "whether easing is needed". It is expected that further interest rate cuts will be required in June and beyond.

Bank of America Merrill Lynch also believes that the 25-basis-point interest rate cut and the dovish tone indicate that the ECB is prepared to enter the easing territory if necessary. It is expected that the ECB will reduce the deposit facility rate to 1.5% or even lower.

As previously reported by Wall Street Insights, the ECB announced its latest interest rate decision on April 17, cutting interest rates by 25 basis points as scheduled, reducing the deposit facility rate from 2.5% to 2.25%, which is the seventh interest rate cut since June last year. ECB officials removed the word "restrictive" from the statement on the monetary policy stance.

Looking ahead, both Citibank and Bank of America Merrill Lynch believe that the economic forecasts of the ECB to be released in June will be key information in determining the subsequent policy path.

Bank of America Merrill Lynch expects that the economic forecasts at that time may show that the medium-term inflation rate is closer to 1.5% rather than the target of 2%. This will further strengthen the case for implementing an accommodative monetary policy.

Citibank also believes that the performance of future economic data, especially the growth and inflation data affected by the US trade policy, will continue to guide the ECB's interest rate decisions towards a downward path.

Citibank: From Restrictive to Easing

The Citibank report emphasizes that the ECB's communication indicates that the focus of the policy discussion has shifted from "whether monetary policy needs to remain restrictive" to "whether a shift to easing is needed".

The report points out that the discussion on evaluating whether monetary policy is restrictive is no longer a relevant reference for policy decisions, which is consistent with Citibank's previous argument that in the face of new shocks, attention should be paid to the change in the interest rate path relative to previous assumptions rather than its neutral level.

Although the ECB did not provide a clear guidance on the future interest rate path this time, the president emphasized at the press conference the determination of the governing council to act at any time and the flexibility of the policy.

The Citibank report points out that the description of the upside and downside risks to inflation in the ECB's monetary policy statement is obviously unbalanced. The downside risks stem from the demand shock caused by the US tariff policy, while the upside risks mainly include hypothetical weather events and their impact on food prices. If this is the only upside risk to worry about, then the probability of an interest rate cut in the coming months is clearly high.

Citibank believes that the market already has a rather clear expectation of the future policy direction. The tightening of financing conditions, uncertainty shocks, and demand shocks caused by tariffs all clearly point to the fact that the ECB will lower its growth and inflation forecasts in June, and the inflation expectation for 2026 may be only slightly above 1.5%. These are sufficient to justify Citibank's expectation of a 25-basis-point interest rate cut in June and at least two more 25-basis-point interest rate cuts thereafter.

Bank of America Merrill Lynch: The Policy Door is Open, and the Threshold May be Breached

The Bank of America Merrill Lynch report points out that the 25-basis-point interest rate cut and the overall dovish tone clearly indicate that the ECB is prepared to bring the policy interest rate into the "easing territory" if necessary.

Based on this judgment, Bank of America Merrill Lynch maintains its forecast that the deposit facility rate of the ECB in this interest rate cut cycle will reach 1.5%.

The report further points out that under the current situation, the risk of delaying interest rate cuts has decreased, while the possibility of a larger interest rate cut in the future is increasing.

Although 1.5% is the baseline forecast, Bank of America Merrill Lynch believes that this is more like a "ceiling". Unless major changes occur to prevent the ECB from lowering interest rates below 2%, there are various scenarios that may lead to the policy interest rate being lower than 1.5%.

The Bank of America Merrill Lynch report believes that the ECB's economic forecasts in June will become a key reference point for the policy path. Based on the existing information, these forecasts may show that the medium-term inflation is close to 1.5% rather than 2%, which will indicate the need to implement an accommodative monetary policy.

The Bank of America Merrill Lynch report also lists a series of dovish signals indicating that the ECB is considering shifting its policy towards easing:

The ECB's concerns about the economic outlook, especially the impact of trade policies and uncertainties, have increased significantly;

Although interest rates may no longer be restrictive, the "financial environment may be tighter", which requires lower interest rates;

The neutral interest rate is regarded as an equilibrium concept, and the current economy is not in an equilibrium state;

The downside risks to inflation have increased (exchange rates, energy, financial environment, trade restructuring), and only defense is regarded as a potential upside risk;

The statement that inflation is broadly in line with the forecast has been removed, indicating the central bank's concern that inflation may decline.

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