UBS Economics-European Economic Comment _ECB Sticking to our call for a J...

ab5 June 2025Global ResearchEuropean Economic CommentECB: Sticking to our call for a July cutDespite hawkish signals, we maintain our call for a final 25bps cut in JulyWhile today's ECB's policy statement was arguably on the dovish side, the press conference was more hawkish. Ms. Lagarde's key statement was: "With today's cut, at the current level of interest rates, we believe we are in a good position to navigate the uncertain conditions that will be coming up." Market participants appeared to take this as a signal that the ECB will pause in July; July pricing retraced from -7bps to -3.7bps; pricing of a September cut was also scaled back from -13bps to -11.6bps. We are not convinced: As we lay out below, we remain concerned that US-EU trade negotiations will not yield a benign outcome over the coming weeks and that tensions might rise again. Hence, we maintain our call of a 25bps rate cut to a terminal rate of 1.75% in July. In our view, the ECB's clear statement that they will maintain a data-dependent and meeting-by-meeting approach also means that today's comments should not be seen as strong guidance for the July decision. However, if we turn out to be too pessimistic and US-EU trade negotiations do yield a benign outcome, we would most likely change our call and remove the July rate cut from our forecast. Further out, we think the ECB will hike rates again in late 2026 to prepare for higher (fiscally-driven) inflationary pressure in 2027. New ECB macro forecasts and alternative scenarios The ECB's new macroeconomic projections (prepared by national central banks, not ECB staff), as expected, showed downgrades to inflation projections amid higher US tariffs, while growth projections were relatively little changed. Specifically, the ECB left its 2025 growth forecast unchanged at 0.9%, citing the offsetting effects of strong Q1 GDP and weaker growth expectations for Q2 and Q3 on the back of higher tariffs (assumed to remain at 10%). Trade tensions and the stronger euro were also behind the 0.1pp downgrade to the 2026 GDP growth forecast to 1.1%. The 2027 forecast remained unchanged at 1.3%. On the inflation side, the ECB lowered its 2025 and 2026 forecasts by 0.3pp to 2.0% and 1.6%, respectively, mainly reflecting lower energy prices and a stronger euro. The 2027 forecast was unchanged at 2%. In contrast, the core inflation forecast was raised by 0.2pp to 2.4% for 2025 but cut by 0.1pp to 1.9% for 2026. The 2027 forecast was unrevised at 1.9%. Importantly, the June projections included two alternative scenarios – a "mild scenario" assuming the removal of bilateral tariffs between the US and EU; and a "severe scenario" assuming a further across-the-board increase in US tariffs (to the levels announced on “Liberation day”, implying a 20% tariff on the EU) and symmetric retaliation by the EU. Under the mild scenario, the ECB projects growth to be 0.3-0.4pp stronger in 2025-26 with marginally higher inflation (1.7% in 2025 and 2.1%