The ECB is expected to continue cutting interest rates in 2025 as weak growth and cooling inflation continue. While markets are pricing in a cut to 2%, some analysts suggest deeper cuts could follow if trade risks and global uncertainty escalate, according to a Euronews analysis.
The European Central Bank (ECB) is again in the spotlight for monetary easing, with markets and economists speculating how far Frankfurt may go in cutting interest rates in 2025.
Having cut its key deposit facility rate to 3% in 2024 - a full percentage point drop - economic and inflation trends suggest further cuts could be on the horizon.
Could interest rates fall below the "neutral" level of 2% and what factors could trigger such a move?
The path to the ECB's neutral rate
The ECB's move towards easing interest rates is driven by falling inflation and lacklustre growth.
Annual inflation in the euro area fell from 2.8% in January 2024 to 2.2% in November, and economic growth slowed to 0.4% year-on-year in the third quarter, approaching stagnation.
"After a prolonged period of restrictive policy, our confidence that we are witnessing a timely return to the [2%] target has increased," ECB President Christine Lagarde said in a recent speech in Vilnius.
In its December monetary policy statement, the ECB noticeably reneged on its commitment to keep interest rates "sufficiently restrictive for as long as necessary," signaling a clear shift to a more accommodative stance.
"This trend no longer reflects the evolving macroeconomic landscape, our outlook for inflation or the balance of risks around it," the ECB's Lagarde said.
The latest macroeconomic forecasts show slight downward revisions to inflation projections, with headline inflation expected to reach 2.1% and core inflation 2.3%, before both flattening out at 1.9% by 2026. Growth forecasts have also been revised down, with 1.1% now projected for 2025 - down from 1.3% in September - and 1.4% for 2026 - down from 1.5% previously.
The ECB appears poised to adjust its deposit facility rate to a so-called "neutral" level, a point that is widely believed to maintain economic balance without stimulating or constraining growth.
Money markets are already pricing in a full percentage point cut by the ECB in 2025, which would bring the deposit facility rate down to 2% - its lowest level since January 2023.
"The ECB continues to favour a gradual approach to its monetary easing. We expect rate cuts of 25 basis points at each upcoming monetary policy meeting until the deposit facility rate stabilises at 2.0% in June 2025," Guillaume Dérien, economist at BNP Paribas, noted recently.
The ECB is not a "jack of all trades"
The argument that the ECB sees the 2% neutral interest rate as a likely end point of its tapering cycle stems from the reality that monetary policy cannot always bear the burden of dealing with the economic challenges facing the euro area on its own. Fiscal policy also has a role to play.
Dr Catherine Neiss, chief European economist at PGIM Fixed Income, noted that the ECB's December meeting had shown that the easing cycle may be coming to an end rather than a midpoint. "For our part, we maintain our forecast for further 100 basis point cuts in the key interest rate in 2025, which would take the deposit rate to 2.0%."
ECB President Christine Lagarde reinforced this balanced approach, stating that monetary policy decisions remain flexible and are not set on a predetermined path.
She also stressed that the significant economic challenges in the region cannot be solved by monetary policy alone, arguing that the ECB "cannot serve as a one-size-fits-all instrument" for the European economy.
Wall Street veteran Ed Yardeni, president of Yardeni Research, echoed this view, calling on the European Union to act decisively on governance reforms and economic growth. He pointed to the recommendations of former ECB head Mario Draghi and former Italian Prime Minister Enrico Letta as critical steps to ensure the bloc's future sustainability.
Trump's tariffs and the risk of deeper cuts: Can the ECB lower rates below 2%?
President-elect Donald Trump's promise to impose a 60% tariff on Chinese imports and a universal 10% duty on all other countries is emerging as a major threat to the eurozone. European export-intensive industries - from machinery to pharmaceuticals - face significant risks from reduced global trade volumes.
Bank of America economist Ruben Segura Cayuela sees the ECB's shift from a hawkish to a dovish stance as a signal that more significant cuts could be on the horizon.
"We expect the ECB to cut the deposit rate to 1.5% by September," he said, adding that this outlook implies deteriorating data and increasing risks from global trade tensions.
"The risks of a faster cycle of cuts are important given renewed uncertainty over trade policy and the implications of tariffs."
Goldman Sachs economist Sven Jari Sten also highlighted the possibility of a faster pace of cuts depending on the economic outlook.
"Given our forecast for weak growth and a gradual decline in underlying inflation towards 2%, we are forecasting a 25 basis point cut in January, with the potential for 50 basis points in March."
"Goldman Sachs foresees sequential cuts to bring the deposit rate to 1.75 percent by mid-2025, though Stan noted the risk of "faster and deeper cuts" if conditions deteriorate.
Bill Divini, head of macro research at ABN Amro, predicted that trade tariffs could trigger a disinflationary shock in the eurozone, pushing inflation further below the ECB's 2% target.
"We expect the ECB to cut interest rates by 25 basis points at every Governing Council meeting over the next year, except for the April pause. Eventually, we see the ECB lowering its deposit rate all the way down to 1%," he said. | BGNES
