Croatia, Estonia, Finland, Latvia, Lithuania and Portugal will face off for the European Central Bank’s No. 2 job, according to a statement from the Council of the EU. The crowded race for the vice presidency kickstarts a wider battle for a seat on the ECB’s coveted six-person executive board, the eurozone’s most powerful forum for economic and monetary policy. Four of the seats, including the presidency itself, will become vacant over the next two years. Competition will be fierce, as the eurozone’s largest economies will seek to maintain their influence on the board, leaving smaller countries with fewer seats to fight over. Eurozone finance ministers are set to pick the winner behind closed doors in a secret ballot when they meet in Brussels for this month’s Eurogroup meeting on Jan. 19. The winner will need at least 16 votes from the 21 ministers, representing around 65 percent of the eurozone’s population. Eurozone leaders formally propose the candidate to succeed the outgoing vice president, Luis de Guindos, whose eight-year term ends on May 31. The European Parliament and the ECB are entitled to an opinion about the final pick. Northern European applicants make up the bulk of the contenders, with Finland’s central banker, Olli Rehn, facing competition from Baltic neighbors. These include his central banking peers, Estonia’s Madis Müller and Latvia’s Mārtiņš Kazāks. Lithuania’s former finance minister, Rimantas Šadžius, completes the Baltic round-up. The other two applicants come from Southern Europe: Portugal’s ex-Eurogroup president, Mário Centeno, and the Croatian central bank governor, Boris Vujčić. The candidates are tentatively scheduled to face questions from MEPs behind closed doors before finance ministers meet on Jan. 19.

The European Central Bank left its key interest rate unchanged at 2 percent on Thursday, with the euro area economy still proving itself resilient and with inflation reasonably steady around the Bank’s target. The decision was consistent with guidance from policymakers that monetary policy is in “a good place,” giving them room to wait for year-end projections that will include the ECB’s first inflation forecast for 2028. The economy grew a faster-than-expected 0.2 percent in the third quarter of this year, while preliminary data showed inflation ticking up to 2.2 percent in October, calming fears about a possible undershoot. “The economy has continued to grow despite the challenging global environment,” the ECB said in its statement. “The robust labor market, solid private sector balance sheets and the Governing Council’s past interest rate cuts remain important sources of resilience.” At the same time, however, the ECB warned that “the outlook is still uncertain, owing particularly to ongoing global trade disputes and geopolitical tensions.” Risks remain abundant: beyond potential delayed effects from new U.S. tariffs, they include a further strengthening of the euro, as the U.S. Federal Reserve continues to lower its own rates. On Wednesday, the Fed cut rates by another quarter-point — the second consecutive reduction — citing a slowdown in job growth. Domestically, a delay to Germany’s fiscal stimulus measures and France’s ongoing budget crisis could also threaten to push the ECB out of its “good place.” Even so, a growing number of economists believe the central bank has reached the end of its easing cycle, a recent Reuters survey showed. While a slim majority of analysts last month expected one more rate cut before the end of 2026, nearly 60 percent now anticipate no further changes to borrowing costs in the current cycle.

France’s fiscal troubles will present European Central Bank President Christine Lagarde with a particularly sensitive challenge at her regular press conference on Thursday. Aside from the Governing Council’s latest decisions, the former French finance minister will have to field awkward questions about the situation in her homeland. She faces a tricky balancing act, and will have to avoid suggesting that the ECB may “bail out an unrepentant fiscal sinner” while also taking care not to unsettle bond markets that are still giving France “the benefit of the doubt,” said Berenberg Bank chief economist Holger Schmieding. The Bank is overwhelmingly expected to keep its deposit rate at 2 percent again on the basis of new forecasts showing continued expectations of modest growth. Markets see any further rate cuts as unlikely and think rates will begin to rise again in early 2027. Lagarde will need to manage expectations carefully, HSBC economist Fabio Balboni warned, since ruling cuts out completely could drive up borrowing costs across the eurozone, including in France. “Many countries in Europe face tough fiscal challenges, especially France,” Balboni said. “They simply can’t afford” to spend more money just on interest payments. The situation Balboni describes is something economists call “fiscal dominance,” which occurs when the central bank is forced to keep interest rates low so governments can continue to borrow. Such intervention generally leads to higher inflation in short order. It was debt problems, more than anything else, that brought down France’s government on Monday, after Prime Minister François Bayrou failed to garner enough support for €44 billion in proposed budget cuts for next year. But after initially taking fright when Bayrou called his fateful vote of confidence, investors have largely held their nerve. The spread between French and German 10-year bond yields, a bellwether of market stress, is now at 0.82 percentage points, the widest it’s been all year. But it continues to resemble a slow puncture more than a blow-up. That’s partly because President Emmanuel Macron, who has appointed yet another centrist prime minister, is still trying to build consensus around a deficit reduction plan, rather than call new elections. C’EST LA VIE It has been a humbling summer for France, which has always benchmarked its economic and financial strength against Germany. But as its politics have become increasingly paralyzed and its debts have mounted, markets have come to see it more as a peer of Italy. For the first time this century, Paris’ borrowing costs surpassed those of Rome on Tuesday, albeit only briefly and due to a technical quirk. But the fear is that a growing public debt burden — which stands at over €3.35 trillion — will make the country increasingly vulnerable to a financial crisis. Under Lagarde, the ECB has given itself the power to intervene in bond markets if it feels that unjustified volatility is stopping its interest rates from working as intended, something it calls the transmission mechanism of monetary policy. It drew up the rules for using what it calls the “Transmission Protection Instrument” during the pandemic in 2022, the last time investors were seriously spooked by the size of eurozone budget deficits. Most analysts, such as Swiss Re’s Patrick Saner and UniCredit’s Marco Valli, say the current situation isn’t anywhere near serious enough to justify using the TPI. There is no certainty, however, because the criteria for intervening through the TPI are deliberately vague, giving the ECB full discretion over when and how to use it. On paper, at least, the TPI allows the ECB to buy unlimited amounts of a eurozone country’s bonds from investors, provided that market stress is “unwarranted;” that doing so would not risk stoking inflation; and that the country is not under an EU excessive deficit procedure. Hawks such as the ECB’s head of markets, Isabel Schnabel, have argued that talk of using the TPI today is “far-fetched” insofar as Paris’ problems have no “wider implications for the euro.” | Horacio Villalobos Corbis/Corbis via Getty Images The last criterion would exclude France, but policymakers were careful not to tie their hands, saying these criteria would only serve as “an input” to the decision-making process. It’s anyone’s guess where the ECB’s pain threshold might be. Hawks such as the ECB’s head of markets, Isabel Schnabel, have argued that talk of using the TPI today is “far-fetched” insofar as Paris’ problems have no “wider implications for the euro.” “It would be difficult for the ECB — at least in terms of building a majority at the Governing Council — to use its new arsenal if there is no spillover effect from the country under pressure” to others in the eurozone, AXA group chief economist Gilles Moëc agreed. Moreover, there is no sign yet that bond market conditions are really hurting growth: The Bank of France on Tuesday estimated that the French economy will grow by a respectable 0.3 percent in the current quarter. However, the fear of bond markets suddenly getting out of control runs deep. Last year, Italian central bank chief Fabio Panetta said the ECB should be “prepared to deal with the consequences” of shocks caused by “an increase in political uncertainty within countries,” much as France is currently enduring. Talk of spreads is particularly sensitive for Lagarde, whose cavalier comment during the pandemic that the ECB “is not here to close the spreads” briefly threw markets into a panic. As Raboresearch economist Bas Van Geffen said: “She will not make that mistake again.” The ECB president appeared to try to strike a balance last week in an interview with Radio Classique, saying she was watching the spreads “very closely” while urging Paris to “get organized … and put your public finances in order.”

LONDON — Who’d want to be Rachel Reeves right now? While Britain’s top finance minister has the full-throated support of her boss, Prime Minister Keir Starmer, it’s been a deeply bruising week for the country’s first female chancellor. A humiliating government climb-down on a money-saving welfare reform plan was followed by market-moving tears from Reeves in the House of Commons on what she has stressed is a personal matter. With unfortunate timing, the scene — mocked by opposition politicians — came just as Starmer failed to explicitly endorse Reeves staying in post. He has now very publicly backed her — but the fundamental economic challenges Reeves faces aren’t going anywhere. Reeves’ self-imposed fiscal rules restrict government borrowing. But, after the latest costly welfare climb-down, the keen chess player’s next move could involve tax hikes toxic to swing voters, spending cuts disliked by her Labour colleagues — or both. POLITICO courted the views of six wise heads who have been in the political trenches in the U.K. and further afield to gauge where Reeves might turn next. DON’T APPEASE — JARED BERNSTEIN, FORMER CHAIR OF JOE BIDEN’S COUNCIL OF ECONOMIC ADVISERS AND AN ARCHITECT OF ‘BIDENOMICS‘ Jared Bernstein — who saw Joe Biden lose to Donald Trump despite touting improvements in the economy — urged Reeves not to get too freaked out about public opinion. “If voters are perennially unhappy, they’ll always throw out the incumbents no matter what they do,” he said. “If you try too hard to appease … a deeply unhappy electorate, you won’t have time for anything else.” Reeves’ head is “in the right place” and she should keep her focus and do what she thinks is right, he added. Acknowledging the U.K. economic data is “quite tough” with an “uncomfortably low growth rate bumping up against uncomfortably high interest rates,” Bernstein argued the math is “pretty straightforward.”  “You have to cut spending, raise taxes, or some combination of both,” he said. On the tax-raising front, without breaking manifesto pledges, Bernstein thought there were options “including freezing [income] tax thresholds … for a couple of more years through to 2030.”  “I’ve seen ideas to raise the private health insurance premium tax, some pension tax reform,” he added. “I think there’s a proposal to reduce the revenue level at which businesses pay VAT. And that has potential … [to] be quite revenue-positive.” Chair of the US Council of Economic Advisers Jared Bernstein. | Samuel Corum/EFE via EPA He added: “One has to be mindful of raising the tax burden when growth is already underperforming. But I think some of the suggestions that I just walked through seem pretty marginal to me, so perhaps there’s some action there.” MANIFESTO PROMISES COULD GO — RUTH CURTICE, CHIEF EXECUTIVE OF THE RESOLUTION FOUNDATION Ruth Curtice, the Treasury’s former director of fiscal policy and now boss of a key living standards think tank, said Reeves should consider raising taxes and cutting Whitehall spending — including 2028-29 totals that were set at her spending review just weeks ago. But Reeves should not, Curtice cautioned, touch her fiscal rules. This is especially true because Reeves’ next budget will have less wriggle room. She’ll be working within a four-year timeline and not a five-year one, thanks to Reeves’ changes to fiscal rules. The Resolution Foundation has previously branded the freezing of income tax thresholds a “stealth tax,” but Curtice said Reeves should consider more freezes — and even manifesto-breaching rises in income tax, national insurance or VAT. “She shouldn’t rule out personal taxes, given the sums of money she needs to raise and the economic challenges of raising further business taxation,” said Curtice. “One option is freezing personal tax thresholds, but she might need to be bolder and explicitly break manifesto commitments if she needs big sums of money.” Curtice reckoned Reeves needs to show her general direction of travel much sooner than the fall to avoid a summer of speculation. “Some laying the ground on tax could be helpful … Speculation all the way from now until autumn could be unhelpful economically,” she added. USE BANK OF ENGLAND RESERVES — JAMES MEADWAY, FORMER ECONOMIC ADVISER TO SHADOW CHANCELLOR JOHN MCDONNELL James Meadway — who was once a policy adviser at the Treasury, went on to advise left-winger John McDonnell, and now hosts a podcast called “Macrodose” — suggested Reeves could save billions of pounds a year by moving to a system of “tiered reserves.” “The Treasury indemnifies the losses that the Bank of England somewhat notionally makes on quantitative easing,” he said. “If you introduced a system of not paying so much interest on the reserves that the commercial banks hold at the Bank of England, you could save several billion pounds a year on this.” Meadway acknowledged “the City [of London, Britain’s financial powerhouse] wouldn’t like it” — but reckoned it would be “a lot easier than making more cuts, or raising whacking great taxes elsewhere.” “It would free up billions for the Treasury to spend to get you through what is otherwise going to be an extremely tight budget,” he said, and “keep within the fiscal rules. “The problem that Rachel Reeves really sharply faces … is that you have pinned everything on the fiscal rules,” he argued. “If you say we are now going to change them, that will provoke a reaction of the kind we have just seen through bond markets.” DON’T SURPRISE THE MARKETS — RUPERT HARRISON, FORMER ADVISER TO GEORGE OSBORNE Rupert Harrison — a key Tory ex-aide who is now a senior adviser at investment management company PIMCO — agreed markets would be spooked by any watering down of Reeves’ fiscal rules, with investors already factoring in tax rises.  “The gilt market has already started to react negatively to news about the welfare bill, with yields rising relative to other countries, but the scale of that reaction has been limited by a widespread assumption amongst investors that the government’s response will be to raise taxes in the autumn,” he said. “Any suggestions that the government might look again at watering down its fiscal rules would start to risk a more negative market reaction given the U.K.’s well-known fiscal vulnerabilities,” Harrison added. “Markets now assume that cuts to welfare spending and departmental budgets are effectively off the table — if they start to sense that the political will to raise taxes is also lacking then concerns about fiscal sustainability will grow.” Gavin Barwell, former chief of staff to Theresa May. | Vickie Flores/EFE via EPA GIVE MPS A REALITY CHECK — GAVIN BARWELL, FORMER CHIEF OF STAFF TO THERESA MAY Gavin Barwell, in the trenches as the Theresa May government faced huge disloyalty in the ranks over Brexit, thought Reeves needed to be better at forcing members of parliament to say what hard choices they would actually make. He drew parallels between the current government’s party management woes and the dilemma facing his former boss. “Different people kept putting to parliament different propositions of how to solve the Brexit question, and parliament just kept saying no, but it never had to say what its answer was,” he recalled. “You’ve got to do a better job of exposing to your backbenchers what the realm of possible options are. You can’t ultimately change the fiscal arithmetic. Does the government try and borrow some more money? It is quite difficult in the bond markets at the moment. “Does it tax more? If so, who does it tax? Does it cut spending? If you don’t want to cut spending from welfare, where do you want to cut spending?” He added: “You’ve got to find some way of confronting [MPs] with the reality of the situation, and having some collective decision-making about what are the least bad ways of trying to navigate out of that situation.”   ‘LABOUR MPS MUST DECIDE’ — LUKE SULLIVAN, STARMER’S FORMER POLITICAL DIRECTOR “Rachel Reeves’ position is significantly stronger than is often perceived,” Sullivan — an ex-aide to Starmer who is now a director at the consultancy Headland — pointed out. The prime minister’s “full-hearted support” and the “notable vote of confidence from the financial markets” to Starmer’s endorsement of her show “Reeves is not only secure in her position, but pivotal to the government’s economic credibility.” “While some policy adjustments, such as on welfare, may be understandable,” Sullivan said, he warned Labour MPs must not be under any illusion that the government’s ambitions need anything less than “rigorous fiscal discipline” met by “increased taxation, spending restraint, or other measures.” He added: “None of these choices will be politically easy, but they are necessary and Labour MPs must decide.”

AMSTERDAM — The international trading system must do more to address “persistent, unsustainable imbalances,” Bank of England Governor Andrew Bailey said, acknowledging that U.S. concerns over trade distortions may have merit. Speaking exclusively to POLITICO on the fringes of a Foreign Bankers’ Association event in Amsterdam on Tuesday, the incoming chair of the Financial Stability Board said the postwar multilateral trade system “hasn’t necessarily delivered all it needs to deliver” and that a rethink was due. “We have to have a system which does identify where there are persistent, unsustainable balances,” Bailey said.  The comments come just days after a surprise détente between China and the U.S. on the tariff war launched by Donald Trump’s administration on April 2 calmed financial markets’ worst fears about outlook for the world economy. While reiterating his commitment to free trade, Bailey acknowledged that tariffs — long anathema to orthodox central banking — may have served as a necessary wake-up call to reshape the international trading system. “Obviously the U.S. administration feels it’s had to use tariffs to really get this point out there. I think all of us who believe in free trade and believe in multilateralism are happy to say, ‘Look, okay, we sort of get it.’” Bailey went on to tell the gathering of bankers that didn’t mean abandoning the WTO but rather working with the body to make it fit for purpose again. “We’ve got problems in the trade agreements and monitoring of trade agreements,” he said. “What I really hope is that we address these questions in a multinational way, and that we don’t give up on the multilateral system, because that would be a real setback.” Bailey added that reforms must address both persistent macro imbalances and enforcement weaknesses at the micro level. “The origin of persistent imbalances is in fundamental economics, so that’s where you need to start: what’s causing these fundamental systems advances?” he said, adding that the International Monetary Fund had a role to play, not least because there was now “an acceptance by countries that they have to take those things seriously and … take action upon them.” Citing IMF analysis, Bailey also noted that a significant share of new trade restrictions in the past decade had originated in China. “There has to be a way of dealing with these things, rather than just sort of letting them sit there” while the level of tension rises, he told POLITICO. Bailey’s remarks reflect an emerging openness among European monetary authorities to the argument — long pushed by Washington — that existing trade governance frameworks have failed to adjust to a more state-driven global economy. The outgoing chair of the Financial Stability Board, Klaas Knot, echoed Bailey’s points during the panel session. “Whatever you think about the U.S. administration and their communication, they are dead serious about this global imbalances issue,” Knot told the room. “Not every trade balance needs to be in balance, there’s absolutely no economic reason for it. But, on the other side, there can also be an argument that some of the imbalances actually become excessively large. I do think that there is a sort of upper limit beyond which imbalances become counterproductive.” GEOECONOMICS IN FOCUS Asked whether the increasing entanglement of economic and geopolitical objectives such as tariffs or strategic autonomy  — what some have termed “geoeconomics” — poses a threat to central bank independence, Bailey said the trend underlined rather than undermined the case for institutional autonomy. “I don’t believe [geoeconomics] invalidates independence. It underlines why it was so important to have independent central banks,” he said on the sidelines. “Our job is to take difficult decisions in difficult times … I don’t accept that our independence is politicized in any other sense.” In that respect, Bailey said recent interventions by the BoE — such as its temporary and targeted bond-buying during the so-called “LDI crisis” in 2022 — had been misunderstood in some quarters as monetary stimulus, when in fact they were narrowly targeted at market functioning and financial stability. “It was hugely important to say, ‘No, we’re not doing QE.’ This was a limited financial stability intervention. And we sold the gilts as soon as we could.” Bailey acknowledged that the visibility of central banks during periods of volatility has led to more scrutiny and criticism, but rejected any suggestion that the BoE was pursuing political objectives. Both Bailey and Knot rejected the idea that geoeconomics or the pursuit of strategic autonomy would impinge on their mandates. “In the core of our mandate, I think we will always continue to be focused on price stability [in] the medium term,” Knot said. Where such factors would have more of a bearing, however, would be in payments and in addressing supply-side constraints in the global economy. “Many of these private payment solutions are actually heavily dependent on foreign service providers,” said Knot. “If we develop a digital euro, the payment rails that will come with [it] might also offer an alternative to private initiatives to become less dependent on foreign payment service providers.” Bailey, meanwhile, highlighted that over the past five years, central bankers have had to realize that the supply side of the world economy has become less predictable. “That’s where I think we have to take it on board, but we’re not trying to influence it,” he said. DOLLAR STILL KING Despite European governments’ growing focus on strategic autonomy, both Bailey and Knot pushed back against the increasingly popular market view that Trump’s tariff agenda had ruptured the supremacy of the U.S. dollar. “I think there’s a lot more to the dollar’s status as a reserve currency than some of this commentary recognizes, and actually it’s got even more so in recent years,” Bailey said on the sidelines. “I mean, there’s a huge amount of what I call infrastructure that goes with being a reserve currency these days.” As such, he added, the world was nowhere near de-dollarization. “And by the way, I hope we’re not, because it would be quite destabilizing.”  Knot agreed in the panel session that “there is simply no alternative yet for the role that the dollar plays in a number of functions that an international reserve currency fulfils,” adding that the euro was unlikely to supersede it for as long as Europe’s markets remained fragmented along national lines. “If we can’t resolve these issues, then you cannot expect your currency to become an international sort of reserve currency vehicle,” Knot said.

The next German government is inheriting an economy that could stagnate for a third straight year, Deutsche Bundesbank President Joachim Nagel warned Tuesday. “It is not possible to rule out a third consecutive calendar year with no growth,” Nagel said at a press conference. “This makes it all the more important that the new federal government swiftly take effective measures.” Nagel welcomed what he said was “a clear government mandate and a likely option for a coalition” from an election this past Sunday. Friedrich Merz, leader of the center-right Christian Democrat bloc in parliament, is set to open talks with the center-left Social Democratic Party with a view to forming a government in the coming days. Europe’s largest economy has shrunk slightly for the last two years in a row. High energy prices, the green transformation and demographic change are putting the export sector under particular pressure, Nagel said, adding that high taxes and increasing bureaucracy are making the situation worse. “Smart, consistent and reliable economic policymaking can unleash a sense of change and increase the willingness for greater investment,” Nagel said. Elsewhere, Nagel tried to downplay speculation on how far and how quickly the European Central Bank can continue to cut interest rates, after five cuts in the last eight months that have brought the key deposit rate down to 2.75 percent from a record high 4 percent. “In the current uncertain environment, there is nothing to be gained from publicly speculating on where we might stand, in terms of our interest rate policy, in summer or at the end of the year,” he warned. Nagel was speaking at a press conference to present the Bundesbank’s annual report for 2024, which showed another heavy loss of €19.2 billion due to after-effects of a decade of quantitative easing followed by a sharp rise in interest rates. Nagel said losses will continue for some years yet, but should narrow from now on.

The European Central Bank cut its key interest rates by a quarter-point, as greater confidence that inflation is beaten gives it more space to support an economy threatened by a growing array of risks. The move takes the Bank’s key deposit rate down to 2.75 percent, from a record high of 4 percent last year, and President Christine Lagarde indicated the bank expects further cuts will help to revive growth in a eurozone economy that stagnated at the end of last year, its two largest economies — Germany and France — weighed on by political instability.  For the immediate future, however, it expects the economy to stay weak, not least because its past interest rate hikes in 2022 and 2023 continue to act as a drag: companies and home-owners who took out long-term loans in the days when interest rates were close to zero are still having to refinance those loans at higher levels, forcing them to cut back on other outgoings.  Moreover, it says the risks to its outlook are still skewed negatively, not least due to the new administration in the U.S. and President Donald Trump’s threats of trade tariffs.  CONFIDENCE SAPPED The political environment, both external and domestic, has sapped confidence over the past year, diminishing the impact of four previous cuts that had brought official rates down by a full percentage point. The Bank noted that even though household incomes are more than keeping pace with inflation, people “have not yet drawn sufficient encouragement … to significantly increase their spending.”  “The ECB is clinging on to the optimism that falling rates and rising real wages will translate into a rebound in private consumption, but as we have seen … the confidence to spend them just isn’t there,” Kyle Chapman, a foreign exchange analyst with Ballinger Group, said in e-mailed comments.  “The recovery has been repeatedly delayed, and it is hard to imagine that this turns around in the near term.”  Several members of the ECB’s Governing Council have already voiced such fears, stressing that the ECB should cut rates to a “neutral” level as quickly as possible. Deutsche Bank’s Mark Wall said in e-mailed comments that rates may “quite probably” end up below neutral by year-end.  For the moment, Lagarde said, policy is still “restrictive”, adding that no-one had suggested otherwise at Thursday’s meeting. ECB staff estimate the neutral rate could be anywhere between 1.7 and 2.5 percent.    “The lack of discussion around neutral rates implies that at least two or three more cuts are locked in in policymakers’ minds,” Chapman said.   Lagarde declined to be drawn on how far the ECB still needs to cut to get to a neutral stance, and stuck to the guidance that the Bank “will follow a data-dependent and meeting-by-meeting approach.”  The ECB’s step widens the gap between European and U.S. interest rates: the U.S. Federal Reserve on Wednesday kept the target federal funds rate unchanged at 4.25 – 4.5 percent. That widening gap may put further downward pressure on the euro, at least partially compensating for any tariff effect but pushing up the price of key imports, including energy. This could be further exacerbated if Europe decided to retaliate against possible U.S. tariffs. Reports on Monday suggested that Treasury Secretary Scott Bessent is preparing a 2.5 percent universal tariff, with incremental monthly increases up to 20 percent that would squeeze European exporters more and more tightly. Lagarde said it would be months before the ECB can reliably assess what Trump’s policies mean for Europe.  “There are rumors, there are statements, there are assumptions, but we don’t have anything that is, you know, clear and tangible,” she said.  

The European Central Bank is expected to cut interest rates this Thursday and hint at further easing ahead as policymakers, together with the rest of the world, try to process the implications of U.S. President Donald Trump’s policies for growth. The ECB is universally expected to cut the key deposit rate by a quarter-point to 2.75 percent on Thursday, and some Governing Council members have signaled they want it as low as 2 percent by June. But some analysts believe such signaling may embody little more than reassurance that the ECB will be there to support the eurozone economy if the U.S. does slap import tariffs on its exporters. Eurozone inflation staged an unwelcome comeback in December to hit 2.4 percent, the highest level since July. However, policymakers had expected a temporary blip and have indicated they see the Bank’s baseline scenario as largely intact. This sees inflation reaching the ECB’s target of 2 percent in the course of this year, and is based on assumptions that the Bank will continue cutting its deposit rate gradually to 2 percent. The economy, meanwhile, continues to sputter, only barely compensating for contraction in Germany and France with growth elsewhere around the bloc in January. “As the projections are on track, there is a clear argument for delivering the cuts that are factored in,” said JP Morgan economist Greg Fuzesi. Since last June, the ECB has lowered its deposit rate from a record-high 4 percent to 3 percent currently. Irrespective of the ECB’s commitment to “follow a data-dependent and meeting-by-meeting approach,” several policymakers — including influential French central bank chief François Villeroy de Galhau — hinted last week that they were in favor of back-to-back cuts until the deposit rate hits 2 percent over the summer. THE LONG TARIFF SHADOW The Governing Council’s meeting will be overshadowed by the looming threat of U.S. tariffs. These could affect the eurozone economy in a variety of ways, either by hitting the eurozone’s exporters or in leading the European Commission to impose tariffs of its own in response. Over the weekend, Trump demonstrated his willingness to deploy such measures to force trading partners to concede on other issues, threatening a 50 percent levy on Colombian exports after it refused to accept a plane deporting illegal immigrants back to their home country. The Colombian government immediately backed down and the tariff threat was lifted. By April, the ECB should at least have a much clearer picture of the kind of tariffs Trump will impose on Europe. | Kirill Kudryavstev/AFP via Getty Images The Financial Times reported on Monday that incoming Treasury Secretary Scott Bessent has proposed setting tariffs on all imports into the U.S. at 2.5 percent initially, rising by a similar amount on a monthly basis, subject to negotiations with Washington’s trade partners. That would fall short of the worst-case scenario threatened by Trump before last year’s elections. ECB President Christine Lagarde is due to meet Commission President Ursula von der Leyen this evening in Brussels, and while the ECB said their conversation will not touch on the Governing Council meeting this week, the threat of trade-related impacts on the economy has been a matter of mutual concern for months. WHERE IS ‘NEUTRAL’? While analysts largely agree that an interest cut this week and in March are nailed on, they warned that any guidance beyond that may be premature, given uncertainty surrounding the economic outlook. By April, however, the ECB should at least have a much clearer picture of the kind of tariffs Trump will impose on Europe and whether they pose a meaningful threat to either growth or inflation. The ECB is now openly talking about moving toward a “neutral” policy, from the restrictive one it has pursued for the last three years. However, pinpointing at what level interest rates are neutral — neither stimulating the economy nor holding it back — is an art rather than a science. The ECB estimates it could be anywhere between 1.75 percent and 2.5 percent. ING’s global head of macro Carsten Brzeski argued that hitting the upper end of that range may prompt hawks to push for slower moves thereafter. As rates approach neutral territory, the debate is likely to become more heated. Dutch central bank chief Klaas Knot warned last week against straying into “stimulative mode.” Similarly, Société Générale economist Anatoli Annenkov said that aggressive signals by policymakers last week may have been an attempt at “precautionary guidance ahead of potentially damaging U.S. trade policies.” But if the economy holds up, he said, the ECB may well feel “obliged to switch to quarterly rate decisions after March.”

The collapse of the French government over a belt-tightening spat earlier this month has traumatized more than just the country’s political elite. To many, it was an uncomfortable reminder that Europe’s debt problems, while they may have been overshadowed by other crises in recent years, have never really gone away. And whereas that vulnerability was confined mainly to the edges of the eurozone 15 years ago, today it is lodged at its very heart. The European Central Bank — not an institution generally given to alarmism — warned last month that the combination of high debt, yawning budget deficits and weak growth leaves the region open to a market crisis like the one that almost tore the continent apart in 2011-2012. Yet the lessons learned last time around have helped to contain such fears so far. In the run-up to the no-confidence vote that toppled the government last week, market moves were significant, but orderly. France’s risk premium, or spread, over Germany rose to 0.90 percentage points — the most since 2012. But that was still far from the “big storm and very serious turbulence” that Prime Minister Michel Barnier predicted would greet his exit. So were Barnier and the ECB just giving each other cover? European Banking Federation chief Wim Mijs suggests that sovereign debt crisis talk is little but political saber-rattling by President Emmanuel Marcon and his team. Politicians like to make “a choice between a stairway to heaven or a highway to hell,” he quipped. THIS TIME IS DIFFERENT Equally, the firefighters who put out the blaze a decade ago argue that fears of a eurozone implosion are overblown — but admit that that may not stop a slow and painful European economic demise. The big difference between now and 2010, they say, is experience. In 2010, nobody in the private or public sector had first-hand experience of a systemic banking crisis, and it was not thought impossible that a big bank or a European sovereign could go under. As a result, every new crisis appeared to be the trigger for the next one. Contagion was the watchword of the day. “There was total institutional unpreparedness,” said Peter Praet, the ECB’s chief economist from 2011-2019. Europe has since been busy preparing. It created the European Stability Mechanism, a bailout fund for sovereigns, and endowed it with over €780 billion in paid-up and callable capital. It has entrusted supervision of any bank big enough to cause problems beyond its home country to the ECB, and created the Single Resolution Board to oversee any regionally significant bank failure. At the same time, the ECB has developed two new instruments explicitly to stop the kind of contagion that made the 2010-2013 crisis so virulent. Neither Mario Draghi’s Outright Monetary Transactions nor Christine Lagarde’s Transmission Protection Instrument have been used, but their mere existence means that anyone wanting to speculate on a eurozone break-up must have very, very deep pockets. But more important than any individual response is that the last crisis experience created “a political understanding that problems need to be dealt with in an efficient way, collaborative way” and the ability to agree a response “more easily and quickly” in future, said Patrick Honohan, the central banker who led Ireland through the collapse of its banking system and the subsequent sovereign bailout. “The experience is there. We have done it.” Peter Praet, the ECB’s chief economist from 2011-2019 argued that, while French public debt is clearly too high, the country is facing a political crisis, not a solvency crisis. | Daniel Roland/AFP via Getty Images In other words, today’s starting point is the assumption that Europe will do, in Draghi’s phrase “whatever it takes” to preserve the euro. Contagion, and crisis, only become possible when market belief in that falters. At least in some respects, mustering the necessary political will should be even easier today as everyone faces the same challenges that require massive investments, argued Honohan, pointing to the fact that even Germany is considering easing its tough spending rules. “There’s no split between creditor and debtor countries like there was in Europe in the last debt crisis,” he said. “Since everybody is in the same boat today, Europe is likely to pull together.” Only, some in the boat are baling and paddling more vigorously than others. As Bank of France Governor François Villeroy de Galhau told a radio interviewer recently, France is alone in not having made the reforms that many of its neighbors (“even the Italians!”) have made since the last crisis. And, while political will at the top of the EU pyramid is solid enough, Barnier’s government fell precisely because the opposition majority in parliament — playing to their respective bases — refused to endorse them. Marcel Fratzscher, head of the Berlin-based German Institute for Economic Research (DIW) warned that the multiple-whammy of crises has left people poorer than they would otherwise be and fed support for populist parties. That in turn has paralysed the political process and is now preventing much-needed reforms. BANK-SOVEREIGN NEXUS WEAKENED To Vitor Constancio, who served as ECB vice-president through most of the eurozone debt crisis, the main difference between now and 2010 is that the banking sector is now much more resilient, posing little risk to the economy and the public coffers. Across the largest banks in the region, the so-called CET1 capital ratio — a benchmark for financial strength — has risen to over 15 percent from below 13 percent when the ECB took over as supervisor in 2014. That’s important given how insidiously the bank-sovereign nexus worked last time around. The sovereign debt crisis was preceded by the Global Financial Crisis, in which banks’ massive losses necessitated capital injections and guarantees from governments which, ultimately, couldn’t afford them. Then, when governments needed the money, the banks they had traditionally relied on to buy their bonds a crisis couldn’t oblige. But while bank balance sheets have strengthened, public ones have weakened, due to a lost decade of growth and a succession of economic shocks. The aggregate deterioration has been relatively modest: gross government debt has only risen from 83 percent on the eve of the sovereign debt crisis to 88.1 percent as of the middle of this year. But that masks a sharp deterioration in France, where debt has risen to 110 percent of GDP from 89 percent in 2010. It could be worse. Praet argued that, while French public debt is clearly too high, the country is facing a political crisis, not a solvency crisis. At least in the short term, “there are no doubts that France can finance its budget,” he said. This explains why France’s risk premium over Germany has remained below 100 basis points — a small fraction of the 2,700 basis points Greece had to pay in 2012, and nowhere near even the 200 basis points that Italy had to dish out last year when the ECB’s policy tightening course spooked investors. But the trajectory — and the inability to alter it — are a big worry. “The latest political developments [in France] will further undermine the country’s growth dynamics while increasing the borrowing costs for the government, companies, and households,” said Allianz chief economic advisor Mohammed El-Erian. | Rob Kim/Getty Images “The latest political developments [in France] will further undermine the country’s growth dynamics while increasing the borrowing costs for the government, companies, and households,” said Allianz chief economic advisor Mohammed El-Erian. “Together with political developments in Germany, this will create stronger headwinds to growth in the euro area, undermine responsive policymaking at a crucial time for competitiveness and productivity, and weaken the EU’s negotiating stance vis-à-vis the incoming US Administration.” In all, instead of a 2010-style blowout, the big worry is that of a ‘slow burn’ decline, albeit one that remains capable of flaring up into something worse any time there is an external shock. “One should never exclude that severe market stress could pop-up,” Praet warned. “We have seen that in the U.K. and even in the U.S. Treasury market.” EFG Bank chief economist Stefan Gerlach put it more bluntly: “Having a large public debt is like driving drunk. Sooner or later, you will have an accident. The question is just how severe it will be.”

FRANKFURT — The European Central Bank cut its key interest rate by a quarter-point to 3.25 percent, as a souring growth outlook and weaker-than-expected inflation in September drove rate-setters to step up the pace of policy easing. “The incoming information on inflation shows that the disinflationary process is well on track. The inflation outlook is also affected by recent downside surprises in indicators of economic activity,” the ECB said in its policy statement. The first back-to-back rate cut in 13 years suggests that Governing Council members are increasingly worried about the eurozone’s growth outlook and less concerned about inflation staging a comeback. Gathering in Ljubljana for their annual off-site meeting, policymakers refrained from signaling how quickly, and how deeply, it may cut again, and said its policy remains restrictive pointing to high domestic inflation and wage growth.  “The Governing Council will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction,” the ECB said. Earlier on Thursday, final data for September showed eurozone inflation dropped well below the ECB 2 percent target to 1.7 percent, a downward revision from an earlier estimate of 1.8. While the ECB said it expects prices to pick up again later in the year, it also hinted that price stability might be restored a little earlier than it previously thought. It now expects to declare victory “in the course of 2025”, having earlier predicted the second half of next year. Governing Council member Yannis Stournaras said last week that “the most recent data suggests” a return to price stability in the first quarter of next year. Economists and investors expect the ECB to deliver another cut in December amid mounting signs that the region’s economy is running out of steam and that inflation has been brought under control. “In our view, this is unlikely to be the last cut from the ECB this year,” said UBS Global Wealth Management chief economist Dean Turner.  “Another cut is likely in December, and we expect this will be followed by a series of cuts at every meeting through to June next year, with the deposit rate hitting 2 percent before the ECB reaches for the pause button.” Investors will hope to get some signals on the interest rate path ahead during President Christine Lagarde press conference starting at 14:45 CET but may well be disappointed. “There is so much data coming in that I don’t see why Lagarde would have any incentive to send signals,” said Danske Bank economist Piet Christiansen. (This article is being updated.)