The rate is in a safe neutral position

The European Central Bank has reduced the interest rate to 2 per cent from 2.25 per cent, and it seems to have completed the cycle of reduction of rates from 4.25 per cent in June 2024. Markets are betting that the central bank would not reduce any further when it meets in July. The rate is now in a neutral position, where it can neither stimulate growth nor serve as a restraint.

Bank president Christine Lagarde said at a press conference, “At the current level we believe we are in a good position to navigate the uncertain circumstances that will be coming up.” She also said that the bank does not have any pre-determined position on the rate path, and it will take things as they turn out.

The two major challenges that the European Union (EU) faces is the slow growth in the economy on the continent, and the tariffs that US President Donald Trump had announced on European imports as he did on imports from all American trade partners.

European leaders are looking to negotiations but they have taken a firm position that they will not capitulate to the tariff threats of Washington. Because of lower economic growth, inflation is also aligned to the interest rate.

There is however no clear monetary strategy to handle the present state of the European economy. The obvious way forward is to lower interest still further – and there is room for that between the existing 2 per cent and zero interest rate – to revive domestic investment demand.

The problem that the European economy is facing is the pressure on its exports, which is a major anchor for European economic growth.

In the May World Economic Outlook (WEO), the International Monetary Fund (IMF) says that the euro area will grow by 0.8 per cent in 2025 and by 1.2 per cent in 2026. There is 0.2 per cent reduction in the growth projection for the two years since the January 2025 WEO.

Though the Central, Eastern and South-Eastern Europe (CESEE) seems to be doing slightly better than the advanced European economies, the projected figures show a slowing down of growth. For CESEE, it shows a growth of 2.4 per cent for 2025, a reduction by 0.6 per cent, and 2.7 per cent in 2026, a reduction by 0.4 per cent from the January projections.

Europe’s economic woes precede Trump’s tariff onslaught. And the reasons are many. One of the major issues is the demography. The ageing population impacts the workforce, and the governments are burdened with social security commitments.

It is surprising that the anti-immigrant right-wing parties have been making political headway in the elections across the continent. What Europe needs is an immigration policy to reinforce its workforce, and the skilling of the immigrants to take their place in the factories.

But the governments do not have a policy of integrating the immigrants into the workforce. The second major issue is the burden of climate change and the energy transition that many of the EU members are committed to make. The plain fact is that Europe cannot hope to continue with the old fossil fuel-based production processes. The climate change processes involve financial commitments and the results will be slow in showing in terms of cleaning up the air, the rivers, and the reduction of greenhouse gas emissions. And more importantly, the global markets are changing, and the slowdown of exports will affect the European economy more than ever.

The challenges that Europe faces are formidable. And the political responses have been quite erratic. The rise of right-wing political parties with their outdated notions that there is no climate change and that immigrants pose a problem to the prosperity of Europe is not really helpful.