European Central Bank set for rate cut amid US trade tensions and France's chaos

The European Central Bank is faced with the task of trying to spur the economy back to life while grappling with external risks such as US President-elect Donald Trump threatening new tariffs and political turmoil in France

As US President-elect Donald Trump threatens new tariffs and political turmoil engulfs France, the EU's second largest economy, the question ahead of the European Central Bank meeting on Thursday isn't whether it will cut interest rates, but by how much.

Analysts predict a quarter-point rate cut from the current ECB benchmark rate of 3.25% as the most likely outcome when the bank's rate-setting council convenes at its towering headquarters in Frankfurt. However, a half-point cut isn't off the table for the bank and its President Christine Lagarde, given the new risks that have surfaced since the bank's last meeting on October 17.

Trump's election triumph on November 5 has heightened the possibility of a more protectionist US trade policy, such as new or higher tariffs on imported goods, after he assumes office on January 20. This sends a shiver down the spine of the business world in Europe, where exports play a significant role in growth and employment. Yet, there are also internal risks to consider.

French Prime Minister Michel Barnier stepped down on December 5 after losing a vote of confidence, leaving France without a functioning government and no clear majority in parliament ready or willing to address the country's excessive budget deficit.

Elections can't take place until June. While the fall of the Barnier government hasn't sparked a financial crisis, it does raise questions about how long it will take for France to stabilise its finances.

Carsten Brzeski, chief eurozone economist at ING bank, suggested that a half-point cut "would be a security move to preempt any potential risks for the eurozone economy coming from the next US administration's potential economic policy choices and political woes in France and Germany,".

Choosing a quarter-point move "would rather follow the cautious meeting-by-meeting approach" that the bank has adopted since it began cutting rates in June, said Brzeski. One reason for a smaller rate cut might be the ECB's reluctance to risk appearing to interfere in French national politics: "This is speculation the ECB would clearly rather avoid," Brzeski stated.

Germany's ruling coalition collapsed in November, with a new national election anticipated for February 23. Weeks of coalition talks are expected before a new government is established. This leaves the two largest eurozone economies politically unstable for months.

Business confidence has taken a hit, affecting borrowing, investment, production expansion and risk-taking. The S&P Global's purchasing managers' survey index for November stood at 48.3, indicating an economic slowdown as any figure below 50 suggests contraction.

Investor confidence also dipped post the US election, according to the Sentix survey, falling by 4.6 points to minus 17.5. Inflation has seen a sharp decline, dropping to 2.3% from its peak of 10.6% in late 2022. This shift has moved the focus from controlling consumer price increases to concerns over continued weak growth.

The European Union's executive commission forecasts that the eurozone will grow by 0.8% this year and 1.3% next year. The European Central Bank's (ECB) higher rates have helped curb Europe's inflation surge following the pandemic and Russia's invasion of Ukraine. These higher central bank benchmarks impact borrowing costs across the economy, making it more expensive to borrow and spend, thereby easing pressure on prices.

However, these high rates could pose a risk by potentially hindering the EU's aim of achieving robust economic growth. The mood in Germany has been dampened by a series of announcements about impending job cuts at major firms.

These include auto technology and parts company Bosch, which plans to shed 5,500 jobs, 3,800 of them in Germany; auto supplier ZF Friedrichshafen, which is set to cut between 14,000-15,000 jobs; and Ford Motor Co., which plans to eliminate 4,000 jobs in Europe, including 2,900 in Germany. Steelmaker ThyssenKrupp also plans to make 11,000 cuts.

Volkswagen is reportedly planning to close up to three German plants, according to its employee representatives who are currently negotiating with the company in an attempt to prevent the closures. The ECB sets the interest rate policy for 20 out of the 27 EU member countries that use the euro currency.