FRANKFURT, Germany — The European Central Bank has cut interest rates by another quarter percentage point to boost growth, lowering credit costs for consumers and businesses to support an economy that is struggling to grow – and could soon face even stronger headwinds from threatened U.S. tariffs.

The rate decision Thursday, which was widely expected by economists, was overshadowed by concerns over the potential trade war with the U.S. and over the impact of a surge in European defense spending, two factors that could upend expectations for growth and inflation.

U.S. President Donald Trump has imposed 25% tariffs on Canada and Mexico that affect Europe indirectly through companies that have plants in those countries, and has threatened the EU with similar measures against its auto imports and other goods.

That is already having an impact, said ECB head Christine Lagarde, who said that tariffs “are not good at all and are net negative on pretty much all accounts.”

“It’s even negative before it happens because the, the uncertainty that is generated and the undermined confidence that results from the just the threat of those tariff increases and potential retaliations are putting a brake on, on investment, on, on consumption decisions, on employment, hiring and all the rest of it,” she said at her post-decision news conference.

ECB Lowers Benchmark Deposit Rate

The ECB’s rate-setting council lowered its benchmark deposit rate to 2.5%. That should provide support for growth by making it cheaper to borrow and do things like buy a house or expand a factory. The rate was raised to a record 4% to combat inflation that reached 10.6% in Oct. 2022, but has been reducing it steadily since June.

As inflation has fallen to an annual 2.4%, concern has shifted to weak growth prospects in the 20 countries that use the euro currency. The eurozone showed zero growth in the last three months of 2024, and prospects for this year are muted amid uncertainty U.S. trade policy.

Lagarde said at her post-meeting news conference that with the cut, rates were “meaningfully less restrictive” on economic activity. While she added that the bank was “not pre-committing to a particular rate path,” she opened the door to interrupting the current series of rate cuts April.

“We will have to be agile to respond to the data. But as I said, if the data indicates that the most appropriate monetary policy stance is a cut, it will be a cut,” she said. “If, on the other hand, the data indicates that the most appropriate decision is not to cut, then it will be a pause”

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Conflicting Pressures on ECB Policy

She acknowledged conflicting pressures ahead from a trade conflict that could depress growth and the prospect of more government spending on defense, which could boost growth but also inflation. Those two forces could push the ECB in opposite directions: a hit to growth would call for lower rates in months ahead, while more persistent inflation would argue for keeping rates higher in coming months.

European Union leaders are holding emergency talks to agree on ways to quickly increase their military budgets after the Trump administration signaled that Europe must take care of its own security and also suspended assistance to Ukraine.

Meanwhile growth estimates for Germany, the eurozone’s largest economy, shot up overnight and long-term interest rates rose in response to an agreement by the two parties that will form the country’s next government to loosen constitutional limits on borrowing and exempt defense spending. That is a major turnaround in German budget policy and opens the way for a trillion or more in new borrowing and spending over the next decade.

“A pause at the next meeting to come to terms with the new macro reality now looks like a possibility,” said Carsten Brzeski, chief of global macro at ING bank.