Scenario Eco - Policy fragility

Video editorial - Policy fragility
Michala Marcussen - Group Chief Economist

Is it mission accomplished for the ECB?
The ECB’s June rate cut took the deposit rate to the mid-point of the 1.75-2.25% range that is presently considered in line with neutral. This, combined with the ECB’s forecast that inflation will remain close to the 2% target over the 2025-2027 horizon, allowed President Lagarde to send a signal of patience at the June press conference.
However, while growth is supported by stronger real wages and the prospect of a significant boost to defence and infrastructure spending in Germany, the euro area remains vulnerable. On the domestic front, we see significant structural inefficiencies and high public debt levels in several member states. On the external front, uncertainty remains elevated, and not least when it comes to the future path of US tariffs.

What is the impact of US tariffs?
Somewhat ironically, the first impact of the tariffs was to boost US imports as both consumers and businesses dashed to stock up on goods ahead of the announced tariff implementation. This was very visible in first quarter GDP numbers, where imports and inventories soared. This effect is set to reverse over the coming months.
With the future level of tariffs still unknown, uncertainty marks a second channel keeping both consumers and businesses cautious. While rational at the individual level, such caution is often very costly at the macro-economic level as spending, investment and hiring is held back. Finally, once in place, tariffs, like any other tax, erode purchasing power.
While some manufacturing jobs may return to the US, others could be lost and the risk is that higher production costs will take away purchasing power from the US consumer and weigh on aggregate economic growth.

Can US fiscal offer a boost to the economy?
Rendering previous US tax cuts permanent certainly avoids a fiscal tightening, but concern is that spending cuts and other measures planned will not suffice to tame the US budget deficit. This raises risk of crowding out effects, where the potential positive effects of fiscal stimulus are more than off-set by higher interest rates and more cautious behaviour from the private sector in anticipation of the future need to pay back government debt.
For foreigners, an additional concern in the current budget bill, is a proposed tax measure targeting individuals and companies from countries with tax policies deemed discriminatory by the US Administration.

Will the European Competitiveness Compass deliver?
The European Commission recently offered detailed policy suggestions to each member states on how to boost competitiveness and there is certainly no shortage of ideas. The same is true at the European level with the Competitiveness Compass proposals.
Looking at Europe today, we see very significant opportunities for jobs and investment, but the pace of agreeing and implementing actual policy measures is proving still too slow.
Accelerating the path from good policy ideas, such as those set out in the Draghi Report, to reality is key to Europe’s future success.