As ECB Contemplates Rate Move, Storm Clouds Gather Over Eurozone

Bloc’s economy appears to have slowed, coinciding with mounting tensions over trade and the strength of the euro

By Tom Fairless

A general view of the European Central Bank under dark clouds in Frankfurt, Germany. Analysts have in recent weeks dialed back their forecasts for when the ECB might increase short-term interest rate. Photo: Armando Babani/EPA/Shutterstock 

FRANKFURT—Trade disputes and a stronger currency are threatening a hard-fought economic recovery in the 19-nation eurozone, potentially delaying a move by the European Central Bank to follow the Federal Reserve in increasing short-term interest rates.

Trade conflicts are a particular concern for the ECB because the region escaped the lingering effects of its debt crisis in part due to the strength of its export sector.  
But the bloc’s economy appears to have slowed early this year, coinciding with mounting tensions over possible U.S. tariffs and a fresh increase in the euro’s value against the dollar. A gauge of German business sentiment for April suggested on Tuesday that the slowdown may not be due to one-off factors.

ECB officials, including President Mario Draghi, have indicated that the bank will move only cautiously to withdraw its large monetary stimulus in light of trade disputes and a volatile currency. The ECB isn’t expected to take any policy action when its top officials gather in Frankfurt on Wednesday and Thursday, but the bank might indicate how worried it is about the latest economic data.

“We are all aware that an escalation of protectionist threats from the United States would dampen growth everywhere,” said the head of France’s central bank and ECB rate-setting committee member François Villeroy de Galhau in London on Tuesday. “The recent uncertainty is probably already having some negative effects on investment.” 
Analysts have in recent weeks dialed back their forecasts for when the ECB might increase short-term interest rates, which are currently minus 0.4%. Economists had until recently anticipated a first ECB interest-rate hike as soon as this year, but many now expect the bank to wait until the second half of next year—possibly only after Mario Draghi steps down as ECB president in October 2019.

At the heart of the concerns is trade, which accounts for a much larger share of the eurozone economy than those of the U.S., China or Japan. The eurozone exports goods and services worth 44% of its economic output each year, compared with less than 12% for the United States, 16% for Japan and around 20% for China, according to 2016 figures from the World Bank. 


Exports of goods and services as a percentage of GDP

Note: 2016 Data
Source: World BankNote: 2016 data

Mr. Draghi warned in Washington last week that rising protectionism might already be hurting business or consumer sentiment.

“Trade disputes could potentially have a serious impact on the eurozone economy, particularly Germany, which has in many ways been driving the region’s recovery,” said Stefan Gerlach, a former deputy governor of Ireland’s central bank who is now chief economist at EFG Bank in Zurich.

German Chancellor Angela Merkel and French President Emmanuel Macron are both expected to lobby President Trump this week on trade. French Economy Minister Bruno LeMaire described proposed U.S. tariffs on steel and aluminum imports last week as a “sword of Damocles hanging over our heads.”

To be sure, the eurozone economy appears to be growing robustly for now. The International Monetary Fund this month increased its forecast for the bloc’s growth rate to 2.4% for 2018, from 1.9%—not far off the expected U.S. growth rate of 2.9%. Economists suggest a range of one-off factors may have hurt the economy early this year, from strikes to an outbreak of flu. Businesses may also be struggling to recruit enough skilled workers as the unemployment rate falls, a development that could be viewed positively by the ECB if it helps to push up wages and inflation.

Still, the closely watched Ifo gauge of business sentiment in April slumped to its lowest level in almost a year, Ifo said Tuesday. Germany’s main business lobby, the BDI, warned this week that trade tensions between the U.S. and China represent a big economic risk for German firms.

The strength of the euro—which has appreciated around 15% against the dollar over the past year, to $1.22—partly reflects U.S. policy decisions, according to Ewald Nowotny, who sits on the ECB’s 25-member rate-setting committee as governor of Austria’s central bank.

Investors may be worried about the large U.S. current-account and budget deficits, and consider the euro and yen to be more secure currencies, Mr. Nowotny told reporters in Washington on Sunday.

—Paul Hannon in London contributed to this article.

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