Trump’s tariffs key to whether anticipated ECB hold is an end or a pause

The eurozone’s annual rate of inflation was at the ECB’s target in June, and while the central bank’s economists expect it to fall below that level in 2026, they also expect it to rebound in 2027.

For many policymakers, that suggests they have successfully completed the difficult task of bringing inflation down from a high of more than 10% in late 2022 without pushing the eurozone economy into recession. After cutting the key rate for an eighth time last month, ECB President Christine Lagarde declared that policymakers were in a “good place".

That has led investors to conclude there is no reason for the ECB to cut again this week. But good places seldom stay good for long, and the central bank faces two threats to its serenity.

The most pressing is Trump’s threat to raise tariffs on a broad range of imports from Europe to 30% from 10%. Those higher duties are due to take effect on Aug. 1, and might be reduced through negotiation. But anything higher than 10% would likely lead to slower economic growth and weaker inflation than the ECB had expected.

So it makes little sense for policymakers to change their stance before they know where tariffs are going to settle.

“We expect the ECB to wait and see what happens before reacting, and digest the news in its September forecast," wrote economists at HSBC in a note to clients.

Not only is the ECB unlikely to change policy Thursday, it is also unlikely to give clear guidance as to the future path of borrowing costs, economists say.

“With such high uncertainty ahead of the U.S.-EU tariffs being implemented it would not make sense for the ECB to make a strong statement about future policy when it could be proven inappropriate a matter of weeks or even days later," wrote economists at RBC Capital Markets in a note to clients.

The other cloud on the horizon is the strength of the euro, which has appreciated against the U.S. dollar by around 15% since the start of the year. This is a surprise: usually, the currency of an economy facing higher tariffs would weaken.

A stronger euro damps inflation in the eurozone directly by lowering the prices of imported goods and services. But a stronger currency also compounds the impact of higher tariffs on U.S. demand for goods made in Europe, slowing eurozone growth and cooling inflation.

“Potential effects may only be marginal at this point, but with global sentiment appearing to shift towards a weaker dollar and further euro appreciation, concerns will likely grow," said Ryan Djajasaputra, an economist at Investec.

Should tariffs rise from 10% and the currency remain strong, inflation might fall further below the 2% target in 2026 that is currently expected, and stay below target in 2027. That is a prospect the ECB would likely respond to by cutting borrowing costs, but a call that can only be made in September.

“The stronger euro and the renewed tariff threats are clearly increasing disinflationary pressures for the eurozone, risking inflation undershooting and increasing the likelihood of more ECB rate cuts," said Carsten Brzeski, an economist at ING Bank.

Write to Paul Hannon at paul.hannon@wsj.com