Euro Zone Inflation Faces Pressure from Tariffs, Rate Cuts May Help

Impact of Tariffs on Euro Zone Economy

FRANKFURT, Feb 10 (Reuters) - U.S. tariffs are weighing on euro zone growth and inflation but the most affected sectors are also sensitive to interest rates, so cutting borrowing costs could offset the downward price pressures, a European Central Bank blog post said on Tuesday.

Effects of U.S. Tariffs

The U.S. imposed tariffs on most trading partners last year and ECB officials have been studying their likely impact, often coming to opposing conclusions since trade barriers affect the economy on multiple levels. 

Response of Affected Sectors

But a study done by ECB economists concluded that the drop in demand due to tariffs outweighs any inflation-boosting supply effects, creating a drag for prices.

Inflation Trends and ECB Response

"At its lowest point, about one and a half years after a tariff-related trade surprise that cuts euro zone exports to the United States by 1%, the consumer price level is around 0.1% lower," the blog post, which does not necessarily represent the ECB's views, argued.

Trade data has been volatile over the past year as firms frontloaded purchases to avoid tariffs, which stand at 15% as a baseline for EU goods entering the U.S., then ran down stocks.

However, in the latest three months for which data is available, euro zone exports to the U.S. are down about 6.5% from the same period a year earlier. 

These findings are significant since euro zone inflation fell to 1.7% in January, below the ECB's 2% target, and some policymakers fear that inflation could fall further.

The good news for the ECB is that sectors hit hardest by the tariff shock also respond most strongly to interest rate changes, the blog argued. These sectors include machinery, autos and chemicals.

Output may drop sharply because of tariffs but expands strongly in response to lower borrowing costs, they argued. 

"We find that this pattern holds for about 60% of the sectors we study – representing roughly 50% of total average euro zone industrial output and of total goods exports to the United States," the economists said. 

(Reporting by Balazs Koranyi; Editing by Sharon Singleton)