The European Central Bank cut interest rates as expected on Thursday and kept the door ajar to more, even as a looming trade war with the US and plans to boost military spending drive Europe’s biggest economic policy upheaval in decades.
Easing for the sixth time since June, the ECB lowered its deposit rate to 2.5% in a nod to slowing inflation and faltering growth, and said that rates were still restricting growth, even if less so than in the past.
That wording suggests that more rate cuts may be coming as the bank has long declared that restriction is no longer necessary while inflation, at 2.4% last month, is safely heading back to its 2% target this year.
“Monetary policy is becoming meaningfully less restrictive,” the ECB said in a statement, changing its previous guidance that rates remained restrictive. “The disinflation process is well on track.”
The nuanced language means that another rate cut in April is not a given, as policy hawks are already arguing for caution.
The ECB also lowered its 2025 economic growth forecast for the fourth straight time on Thursday, putting expansion in 2025 at just 0.9, only slightly above the 0.7% pace recorded last year.
Inflation was meanwhile seen at 2.3% this year, above the 2.1% seen three months ago.
“The downward revisions (in growth) for 2025 and 2026 reflect lower exports and ongoing weakness in investment, in part originating from high trade policy uncertainty as well as broader policy uncertainty,” it said.
ECB President Christine Lagarde may acknowledge that these projections only partially reflect the outlook given exceptional changes since the cut-off date for preparing these figures.
A trade war with the United States is looming and firms are already holding back investment, awaiting clarity on measures to be directed at the European Union and how tariffs imposed on others could redirect trade flows.
Meanwhile Germany and the European Commission have both announced transformational changes in fiscal rules to boost defence and infrastructure spending, partly to replace US support for Ukraine – a tectonic shift that could impact growth for years.
While more spending is better for growth, it could also add to price pressures, and measures of longer-term inflation have surged from around 2.05% early this week to 2.24% by Thursday, an unusually large shift.
But the ECB does not act on short-term volatility so that change will not be enough for now to alter the debate, even if policymakers are likely to notice and raise the issue in the coming weeks.
The projections are still relevance since they embed market bets on rate cuts and with inflation is still seen at 2% by the end of the year, then at least two more rate cuts remain the ECB’s base case.
Also suggesting that easing has room to run, the ECB’s models show the deposit rate stops restricting growth in the 1.75% to 2.25% range.
A key item to watch in Lagarde’s 1345 GMT press conference is whether she maintains her line that the direction of policy is clear and only the timing and magnitude of easing up for debate.
For now, investors think the ECB will keep going, even if a surge in budget spending could eventually change the outlook.
Markets are pricing almost two more rate cuts this year after Thursday’s move, slightly less than before Tuesday’s German budget announcement but still broadly in the range of expectations seen in the past few weeks.
Meanwhile, Benchmark Bund yields rose again on Thursday after recording their biggest daily rise in more than 25 years the previous day, as Berlin’s plans for a huge spending package led investors to expect a sharp increase in German bond supply.
Yields ticked higher after the European Central Bank cut interest rates by 25 basis points to 2.5% as expected, but revised up its near-term inflation forecasts.
Germany is in for a massive ramp-up in spending, with a 500 billion euro ($540.90 billion) special fund sought for infrastructure and plans to unshackle defence investment from restrictive borrowing rules.
“Given inevitable lags in fiscal policy, additional spending could only start to filter through to the economy later this year and into 2026,” said Mark Haefele, chief investment officer at UBS Global Wealth Management.
“But despite these caveats, the bold fiscal plan has the potential to boost growth and support euro zone assets,” he added, mentioning a possible lift to confidence and an improving backdrop for equities.
Yields on 10-year Bunds were up 7 basis points at 2.849%, after hitting 2.929%, their highest since October 2023.
Agencies
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