Europe must brace itself for potential shifts in US trade policy, European Central Bank President Christine Lagarde has warned, saying that, while President Donald Trump’s administration refrained from imposing blanket tariffs on his inauguration day, selective measures could still emerge in the coming weeks. 

Speaking at the World Economic Forum in Davos on Wednesday during an interview with CNBC, Lagarde stressed the need for Europe to “be prepared and anticipate what will happen in order to respond”.

Could a trade war with the US be on the horizon?

Trade is always a big talking point in Davos, but with Trump back in the White House, fears of US protectionism are stealing the spotlight. 

Europe has long advocated for open markets, not just as a “moral principle,” but also because it benefits economically from trade with the US. The eurozone’s trade surplus with the United States stood at nearly 1% of gross domestic product in 2023, driven by key sectors such as chemicals and pharmaceuticals.

Addressing the possibility of Europe withstanding a trade war, Lagarde acknowledged that, while discussions must continue, the idea that the US could significantly reduce imports from Europe to boost domestic manufacturing is “questionable,” because the US economy is “running hot at the moment”.

With the US economy running at full capacity and unemployment at historically low levels, she suggested that replacing European imports with domestic production “will take a bit of time”.

A renewed push for European competitiveness?

The conversation also touched on European competitiveness, an issue that dominated discussions in 2024. 

Lagarde indicated that “the diagnosis is done” regarding Europe’s economic future, citing reports by former ECB President Mario Draghi and economist Enrico Letta that called for urgent reforms on productivity and innovation amid demographic challenges.

Europe’s response must now be “action, action, action”, she insisted.

Trump’s leadership could be catalyst for reform

Lagarde emphasised that Europe moves when it faces an external threat, and the uncertainty surrounding US trade policy could act as a catalyst for reform. 

She highlighted that Europe’s economic strength lies in its large consumer market, but internal barriers remain a challenge. 

“We created the Single Market… but we did not finish the job”, Lagarde noted, pointing out that unresolved barriers to the free movement of goods and services could weaken Europe’s position in global trade negotiations.

Monetary policy: is the ECB falling behind the curve?

On monetary policy, Lagarde reinforced the ECB’s commitment to measured, data-dependent rate reductions, resisting market speculation over the pace and magnitude of the cuts.

She reiterated confidence that inflation will fall to the 2% target this year. 

Markets are currently pricing in multiple ECB rate cuts this year, with some analysts predicting four reductions by summer, bringing rates from 3% to 2%. 

ADVERTISEMENT

When asked if this pace seemed appropriate, Lagarde avoided committing to a timeline, saying that “gradual moves” are likely but that decisions will remain data-dependent.

Lagarde also dismissed concerns that the ECB is falling behind the curve on rate cuts, pointing out that “we have not revisited inflation forecasts much in the last five sets of projections”, reinforcing confidence in the central bank’s current approach.

The US-EU divergence in interest rates

One key difference between the ECB and the US Federal Reserve is the pace of monetary easing. 

While the Fed has signalled a more aggressive rate-cutting cycle, the ECB has taken a more cautious approach. 

ADVERTISEMENT

Lagarde acknowledged this divergence, explaining that it reflects “a different economic setting” between the two regions.

With inflation in Europe stabilising and economic growth forecast at 1% in 2025, the ECB is taking a measured stance. 

Lagarde reiterated that the central bank’s focus remains on price stability, and that its mandate does not include factors like employment, unlike the Fed’s.

Energy prices and global uncertainty

Lagarde also flagged energy prices as a key variable in future monetary policy decisions, suggesting that further declines in oil and gas costs could have a significant impact on inflation dynamics. 

ADVERTISEMENT

She remained cautious about giving forward guidance, stating that “we will apply the method and take all the data as it comes”.

As Europe navigates an increasingly uncertain global landscape, the ECB remains committed to its gradual, data-driven approach, while policymakers keep a close eye on US trade decisions and their potential economic fallout.