ECB cuts rates on weak growth, markets bet on more easing

By Francesco Canepa and Balazs Koranyi

FRANKFURT (Reuters) - The European Central Bank cut interest rates for the seventh time in a year on Thursday and warned that economic growth will take a big hit from U.S. tariffs, bolstering bets for even more policy easing in the months ahead.

The ECB has taken borrowing costs to their lowest level since late 2022 as the sharp post-pandemic inflation spike has largely disappeared and fast-moving changes to trade policies sap business confidence and depress growth.

"Downside risks to economic growth have increased," Lagarde told a press conference after policymakers agreed unanimously to cut the ECB's benchmark rate by 25 basis points to 2.25%.

"The major escalation in global trade tensions and associated uncertainties will likely lower euro area growth by dampening exports, and it may drive down investment and consumption."

While Lagarde gave away almost nothing about the bank's next moves, insisting policymakers would decide meeting-by-meeting, some of her colleagues said the bar for further cuts is low.

Sources speaking to Reuters on condition of anonymity said that a cut in June was still highly possible and only a major easing in trade tensions would persuade them to pause.

Markets also took Lagarde's warnings about growth risk as a signal that more easing will be necessary and priced in another two or three rate cuts before borrowing costs bottom out.

"We are convinced that there are more rate cuts to come," ING economist Carsten Brzeski said. "The ECB's sense of urgency has clearly increased."

"However, everyone should know by now that rate cuts alone will not shield the eurozone economy against the current historic changes and challenges."

Nevertheless, Lagarde insisted that governors would keep an open mind and sources inside the room said the Governing Council was balanced on Thursday. Unlike in some past meetings, there was no clear dominance by either policy "hawks" or "doves".

Lagarde also downplayed the significance of the ECB's decision to omit the last reference in its regular statement to interest rates restricting economic growth.

While Trump has paused most tariffs for the time being, many remain in place and volatility in financial markets has already done damage to the economy.

Lagarde said the ECB would not have full clarity by its next meeting in early June as that was before the end of the 90-day freeze Trump has put on his tariffs - set at 20% for the European Union.

The recent turmoil had led the vast majority of economists polled by Reuters to expect Thursday's cut in the ECB's deposit rate to 2.25% - the top of a 1.75%-2.25% range it has defined as "neutral", neither boosting nor restricting economic activity. 

TARIFF HIT

Lagarde said last month the ECB estimated that growth across the 20 countries that share the euro could fall by half a percentage point if the United States imposes a 25% tariff on EU imports and the bloc retaliates, erasing about half the euro zone's expected expansion.

But that estimate has been seen as too optimistic, particularly if a trade war wreaks havoc with investor, business and consumer confidence. 

While the ECB expected a trade war to increase inflation by 50 basis points, volatility caused by erratic U.S. trade policy could equally detract from it. Nearly all financial indicators impacting prices have shifted dramatically in recent weeks. 

"In our main scenario, we see two more rate cuts to 1.75%," Commerzbank economic Joerg Kraemer said. "However, if Trump were to return to higher reciprocal tariffs permanently, a lower deposit rate would be likely."

The euro has firmed 9% against the dollar and trades at an all-time high on a trade-weighted basis, energy prices are sharply lower, growth is slowing, and China, the number one target of U.S. tariffs, could dump some of its output on Europe.

A number of investment banks have trimmed their forecasts for euro zone inflation this year, often lowering it to or below the ECB's 2% target.

"Disinflationary forces are piling up," HSBC wrote in a note as it cut its inflation forecast to 1.9% for this year and 1.8% for the next.

(Writing by Balazs Koranyi in Frankfurt and Marc Jones in London, Editing by Catherine Evans)