Weaker Euro and U.S. Tariffs' Impact on ECB Policy

By Divya Chowdhury and Francesco Canepa

MUMBAI (Reuters) – A weaker euro falling to parity with the dollar would cushion the impact of any new U.S. tariffs on euro zone growth, although it would push up inflation, European Central Bank policymaker Pierre Wunsch told Reuters on Wednesday.

The Belgian central bank governor stated in an interview with the Reuters Global Markets Forum that market bets on four more ECB rate cuts next year were a "meaningful" scenario. However, he is open to altering the approach should inflation and growth data necessitate a change.

The ECB cut rates last week due to a gloomy outlook, with policymakers indicating that already lowered growth projections might be too optimistic if U.S. trade policy moves toward protectionism under President-elect Donald Trump.

Wunsch stated that a lower euro exchange rate against the dollar could mitigate the effects of new U.S. tariffs on euro zone imports. "We've already seen the euro depreciating maybe 4% or 5% against the dollar," he noted. "So it would only take the euro to go to parity for a 10% tariff to be essentially compensated."

However, a weaker currency could increase inflation by making imports pricier, he cautioned.

Previously regarded as a hawk favoring higher borrowing costs, Wunsch expects the ECB's policy rate, currently at 3%, to drop by another percentage point if inflation stabilizes at the ECB's 2% target.

"I guess we will land at somewhere around rates of 2% based on our forecast," he expressed, adding that market expectations of four ECB rate cuts of 25 basis points each in the next four meetings align well with the central bank's outlook. "I am comfortable with it as a scenario that I find meaningful," he said.

The ECB is set to review its long-term strategy next year. Wunsch suggested that the bank should remove language in its strategy document about responding in an "especially forceful" manner to below-target inflation.

He argued that extraordinary measures like massive bond purchases and negative rates prove effective primarily during poor economic conditions, showing little impact when the economy is strong.

"I personally believe that we will have a not-so-easy discussion on the issue of reacting forcefully when we see inflation moving below target," he remarked. "I'm not sure there is this broad consensus that as soon as you move to somewhere below 2% – not on a purely temporary basis – that you have to react very forcefully."

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