The European Central Bank (ECB) announced this week that it was cutting rates as concerns grow over weakening growth and political instability in France, as well as worries about President-elect Donald Trump's tariff threats.
The Rate Cuts
The bank's rate-setting committee announced Thursday from its Frankfurt headquarters that it is lowering the benchmark rate from 3.2 percent to 3 percent. The bank stated that its efforts to bring inflation back to the 2 percent target are proving successful.
"The disinflation process is well on track," the bank said in a statement, however they predicted a "a slower economic recovery" than previously projected.
Concerns of Trump Tariff Threats
Lower interest rates are aimed at bolstering growth as the post-pandemic recovery shows signs of slowing across the 20 countries using the euro.
Concerns are also mounting that Trump could impose new tariffs on imported goods after his January 20 inauguration. The prospect has unsettled European businesses, where exports play a crucial role in driving growth and sustaining jobs.
Internal Risks
French Prime Minister Michel Barnier resigned on December 5 after losing a vote of confidence, leaving France without a functioning government and no clear parliamentary majority to address the country's mounting budget deficit.
With elections not possible until June, the collapse of Barnier's government hasn't sparked a financial crisis, but it has deepened uncertainty over how long it will take for France to stabilize its finances.
Germany's governing coalition collapsed in November with a national election set for February 23. The vote will likely be followed by weeks of coalition negotiations before a new government is formed, leaving the eurozone's two largest economies without political direction for months.
These factors have eroded the confidence businesses rely on to borrow, invest, expand production and take risks. S&P Global's purchasing managers' index dropped to 48.3 in November with readings below 50 indicating economic contraction. Meanwhile, the Sentix investor confidence survey fell by 4.6 points to minus 17.5 in its first update following the U.S. election.
Inflation has dropped sharply to 2.3 percent, down from its peak of 10.6 percent in late 2022, shifting focus away from controlling consumer prices to concerns over sluggish economic growth. The eurozone economy is projected to expand by just 0.8 percent this year and 1.3 percent in 2025, according to forecasts from the European Union's executive commission.
The European Central Bank's rate hikes have been instrumental in curbing inflation following the pandemic and Russia's invasion of Ukraine. By raising benchmark rates, the ECB pushed up borrowing costs across the economy, discouraging spending and investment, which in turn eased price pressures.
This article includes reporting from The Associated Press.
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