ECB warns of ‘sizeable’ hit to growth from a trade war

AMSTERDAM/NICOSIA (Reuters) – Global economic output would suffer a “sizeable” loss if trade became more fragmented and an immediate boost to inflation would only fade over a few years, the European Central Bank’s chief economist Philip Lane said on Thursday.

His comments were the starkest warning so far from the ECB about the consequences of a global trade war, which has been on the top of investors’ minds since Donald Trump won the U.S. presidential election this month on a protectionist agenda.

“Trade fragmentation entails sizeable output losses,” Lane said in slides prepared for a speech in Amsterdam.

Lane envisaged a scenario in which global trade is increasingly divided between Western countries and a China-led East.

He put the hit to global output at between 2%, if all sectors are hit by partial trade restrictions, and nearly 10% under a full ban.

His estimates for the European Union were of similar magnitude, while the United States would fare a little better than that and China much worse.

“Under all scenarios China gets whacked,” Lane said during his presentation.

The global inflationary effects would only “subside gradually” over four or five years after an initial boost of between 60 basis points in a “mild decoupling scenario” and up to nearly 400 basis points under severe assumptions, Lane said.

Speaking earlier in Cyprus, Christodoulos Patsalides, governor of the Central Bank of Cyprus, said Europe could face a recession coupled with high inflation if Trump imposes the threatened tariffs.

“If trade restrictions materialise, the outcome may be inflationary, recessionary or worse, stagflationary,” he told a conference.

Still, the ECB could for now continue to lower interest rates with the next move possibly coming in December, Patsalides said.

“While growth in the euro area economy has been anaemic for some time now, the approach to rate cuts must be gradual and data driven,” Patsalides said. “If incoming data and new projections in December confirm our baseline scenario, there would be room to continue lowering rates at a steady pace and magnitude.”

The ECB has cut rates by a combined 75 basis points to 3.25% this year and investors have fully priced in another move on Dec. 12, with most also expecting cuts at each policy meeting through next June.

Inflation has fallen rapidly in recent months and the ECB said in October it now expects it to oscillate around the 2% target in the coming months. It could then settle at the target in the first half of the 2025, earlier than the ECB last predicted.