How to navigate tariff chaos: Five questions for the ECB

By Yoruk Bahceli, Stefano Rebaudo and Dhara Ranasinghe

LONDON (Reuters) -The European Central Bank meets on Thursday with all focus on what the tariff chaos means for how much further policymakers will need to cut rates.

U.S. President Donald Trump first announced reciprocal tariffs around the world, including 20% on the European Union earlier in April before suddenly dialling back those duties last week for a 90-day period, whipsawing financial markets.

The resulting additional time to negotiate has barely relieved jittery markets and the outlook hasn't become any more certain. The U.S. excluded some electronics imports from steep tariffs on Friday, then said the move would be short-lived, the latest source of uncertainty.

"It will be very interesting how they (the ECB) walk that fine line between acknowledging what needs to be acknowledged without putting too stressed a tone to it," said Morgan Stanley chief European economist Jens Eisenschmidt. 

Here are five key questions for markets:

1/ Will the ECB cut rates next Thursday?

Most likely. 

Traders fully price a 25-basis-point cut, bringing the ECB's deposit rate to 2.25% next Thursday, a move they had seen as more of a coin toss before catching on that Trump's reciprocal tariffs were really on the way. 

Societe Generale said it wouldn't rule out a larger 50 bps cut to more clearly exit a restrictive monetary policy stance.

Policymakers had previously looked more divided on an April cut, but several have since suggested that tariff developments have strengthened the case for a move. 

2/ How will Trump's latest tariffs impact growth and inflation?

Hard to say, given negotiations ahead. But even with the 90-day reprieve, the EU is still being hit by a broad 10% tariff, not to mention higher rates on steel, aluminium and cars, so they will certainly hurt growth.

Before Trump's U-turn on Wednesday, ECB sources told Reuters a previous estimate of a 0.5-percentage-point hit to growth in the first year was too low and could even exceed 1 percentage point, which would wipe out all expected growth for 2025.

The impact on inflation is more ambiguous and will depend on the degree of retaliation against Trump's tariffs and, longer term, on how fragmented global trade becomes. 

But for now, oil prices have tanked 13% this month, the euro is up over 9% since the start of March while China, the biggest source of EU imports, is taking the biggest hit from tariffs, all pointing to further disinflation. 

"There is an across-the-board downward revision to the growth forecast and also because the euro has been so strong, which helps dampen inflation, (the ECB) can in the short-term focus on growth," said Principal Asset Management chief global strategist Seema Shah. 

3/ So will the ECB have to speed up rate cuts?

Markets certainly think so. 

Traders now expect the ECB to cut rates twice more this year after Thursday. That's quite a change, given they had seen less than a full chance of another move this year and priced in the chance of a 2026 hike when the bank last convened in March.

But economists see a more modest path. The median expectation in a Reuters poll was for just one further cut, putting rates at 2% in the second half of the year.

"The fundamental problem, that we are facing very high uncertainty as to what type of economic policy we can expect out of the U.S., that has not gone away," said Morgan Stanley's Eisenschmidt, a former ECB economist.

4/ Will German stimulus come to the rescue?

Not yet. 

Germany's historic debt-rule overhaul to ramp up infrastructure and defence spending is seen as a game changer for the European economy, but it will take time to feed through. 

"The economic impact of German fiscal spending is a story for 2026, not 2025," said Simon Wells, HSBC's chief European economist.

5/ How concerned is the ECB about financial stability?

Policymakers don't seem alarmed yet, but have stepped up their monitoring of banks and markets.

Euro zone bonds have also swung, but been less volatile than U.S. Treasuries, while the gap in borrowing costs between poorer member states and Germany, Europe's largest economy, has not widened to worrying levels.

But the ECB remains concerned that financial stress could spread from non-financial entities to regular lenders in periods of market stress. Hedge funds unwinding some debt-laden bets is thought to have played a role in recent volatility.

"I expect them (the ECB) to say they are ready to act if volatility in the market is unjustified by the fundamentals," said Gregoire Pesques, fixed income chief investment officer at Europe's largest asset manager Amundi.

Indeed, ECB chief Christine Lagarde said on Friday the bank is ready to deploy its instruments to maintain financial stability and has a solid track record in devising new tools when required.  

(Reporting by Yoruk Bahceli, Stefano Rebaudo, and Dhara Ranasinghe; editing by Amanda Cooper, Mark Heinrich and Toby Chopra)