After months of rollercoaster uncertainty, the euro zone, at the end of last year, settled into a strange and unexpected equilibrium.
Inflation had came down to the European Central Bank’s (ECB’s) 2 per cent target rate quicker than anyone had expected, courtesy of easing energy prices and a weak dollar, while growth remained steady, even surprising a bit on the upside.
This prompted the ECB to enter into a holding pattern on interest rates, with ECB president Christine Lagarde noting that monetary policy was now in “a good place”.
Policymakers talked about the resilience of the euro zone economy in the face of Donald Trump’s aggressive trade posture.
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But it was difficult to say for sure whether what we were witnessing was resilience or lag. Economic shocks take time to play out, and the impact of US tariffs on the US economy and global trade is only slowly emerging.
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For a variety of reasons, including the front-loading of exports into the US to evade tariffs, which has distorted the trade data, the picture has been cloudy.
The Irish economy grew at an accelerated rate of 12.6 per cent in gross domestic product (GDP) terms last year, a jump that was driven in part by Eli Lilly fast-tracking ingredients for its top-selling weight loss drugs Zepbound and Mounjaro from Ireland into the US during the first four months of 2025.
This trend is now unwinding, while the impact of tariffs is also slowly emerging.
In the latest three months for which data is available, euro zone exports to the US fell by about 6.5 per cent on the same period last year.
These findings are significant, since euro zone inflation fell to 1.7 per cent in January, below the ECB’s 2 per cent target, and there is mounting speculation it might fall further.
If US tariffs continue to weigh on euro zone growth and inflation, the case for cutting interest rates further, which had been all but extinguished before Christmas, will become live again.
Central Bank governor Gabriel Makhlouf stuck to the party line yesterday, saying there was no holding pattern, and decisions would be data-dependent.
“There’s so much uncertainty, we’re going to continue our meeting-by-meeting approach, looking at the data,” he said.
A blog post published by ECB economists, which does not reflect the view of policymakers but nonetheless provides insight into the thinking within the institution, noted that the sectors hit hardest by the tariff shock also responded most strongly to interest-rate changes. These sectors include machinery, autos and chemicals.
“When trade falls by more than expected after a rise in tariffs – a situation we call a “tariff-related trade surprise” (TTS) – euro area inflation declines and economic activity weakens over the medium term,” the economists said.
“Our results therefore suggest that the effects of the drop in demand due to US tariffs on the euro area outweigh any inflation-boosting supply effects,” they added, while noting monetary policy, a rate cut, could “soften these effects”.
