The European Central Bank (ECB) is expected to cut interest rates again on Thursday. This will likely be its last easy decision for a while. Trade wars and rearmament are driving the continent’s biggest economic policy upheaval in decades.
The outlook is shifting faster than economic models can match. Policymakers are increasingly split about the need for more support. The focus will be on the signals the ECB sends about future moves.
The euro zone’s central bank has telegraphed another 25 basis point reduction in the deposit rate. This cut will take the rate to 2.5% on Thursday. This follows rapid borrowing cost reductions over the past nine months as inflation retreated and economic growth faltered.
The outlook beyond Thursday is more complicated.
Rates are slowly approaching a level that no longer restricts economic growth.
This might normally herald an end to the easing cycle, but these “aren’t normal times.”
A trade war with the United States is looming. Firms are holding back investment because they fear an extended conflict that will hurt demand. Growth is already taking a hit.
Germany and the European Commission have both announced transformational changes in fiscal rules. These changes are designed to boost defence and infrastructure spending, partly to replace U.S. support. This “tectonic shift” could impact growth for years.
Bank of America analysts said in a note, “This is the last ‘easy’ cut as disagreement grows.” They added, “We don’t think the guidance will change … but we would expect growing disagreement among Governing Council members.”
The ECB will struggle to keep up with the rapid change in the outlook.
Their new economic projections are likely to show weaker growth and a slightly higher inflation trajectory. These projections are based on data collected weeks ago.
Policymakers will be more pragmatic. They recognize that the world has moved on since the cut-off date for the forecasts. They now face exceptional uncertainty.
Davide Oneglia of TS Lombard said, “There will be pressure to slow down ECB easing, owing to growth re-rating, although cooling wages and employment, lags in fiscal policy effects, and escalating U.S. tariff threats against the EU keep a sub-2% deposit rate as the base case.”
The key is to watch whether the ECB maintains its language that policy “remains restrictive.” Dropping it would suggest policymakers feel they are close to achieving their aim.
Even removing that phrase would not necessarily mean a pause. Instead, it could signal greater uncertainty and a noisy debate leading up to the next policy meeting.
The ECB’s projections themselves embed market bets on rate cuts. Therefore, if inflation is still seen at 2% by the end of the year, then two more rate cuts will remain the ECB’s base case.
The ECB’s models also suggest that easing has room to run. These models show the deposit rate stops restricting growth in the 1.75% to 2.25% range.
Another item to watch is whether ECB President Christine Lagarde maintains her line. Does she still assert that “the direction of policy is clear” and only “the timing and magnitude of easing” is up for debate?
For now, investors think the ECB will keep going.
Markets are pricing two more rate cuts this year after Thursday’s move. This is slightly less than before Tuesday’s German budget announcement. However, it is still within the range of expectations seen in the past few weeks.
The ECB will announce its policy decision at 1315 GMT. Lagarde’s press conference will follow at 1345 GMT.
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