ECB cuts interest rate to 2.5%

The European Central Bank has signalled a possible slowdown in cuts to borrowing costs, as rate-setters reduced their benchmark interest rate by a quarter point to 2.5 per cent.

Thursday’s widely expected move was the sixth reduction in the ECB’s deposit rate since the central bank started its rate-cutting cycle last June, when the benchmark stood at a record high of 4 per cent to counter surging inflation. 

In a change of tone that signalled a more hawkish stance, the ECB said that “monetary policy is becoming meaningfully less restrictive”.

The language suggested a possible slowdown or pause in future interest rate cuts, since it compared with the ECB’s previous wording that “monetary policy remains restrictive”.

Christine Lagarde, ECB president, said the shift in wording was “not an innocuous little change”. Lagarde raised the prospect of pausing the ECB’s run of rate cuts, saying rate-setters would be led by what “the data indicates”.

Lagarde also said there was no opposition to the decision to cut rates — though one rate-setter, Austria’s hawkish central bank governor Robert Holzmann, abstained.

In the aftermath of the decision, traders trimmed their bets on future rate reductions.

While they continued to fully price in one further quarter-point cut this year, according to levels implied by swaps markets, the chance of a second cut in 2025 fell from about 85 per cent to roughly 70 per cent by late afternoon.

The euro rose against the dollar after the ECB decision, before later giving up some of the gains, up 0.1 per cent at $1.080.

Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said the ECB was “no longer on autopilot” and had made a “meaningful, albeit conditional, hawkish shift”.

Inflation has fallen from a peak of 10.6 per cent in October 2022 to 2.4 per cent in February and the deposit rate is now at its lowest since February 2023.

The prospects for the Eurozone economy could also be affected by moves by Friedrich Merz, Germany’s chancellor-in-waiting, to unleash hundreds of billions of euros in borrowing to boost defence spending and overhaul his country’s infrastructure.

Merz’s fiscal bazooka had prompted traders to reduce their expectations for ECB rate cuts even before Thursday’s decision. Some analysts forecast that a quick implementation of the plans could double Germany’s expected growth next year to 2 per cent.

In projections that did not take into account the German plan, the ECB cut its growth forecast for 2025 — its sixth successive downgrade for the year — as well as for 2026 and 2027.

It now expects Euro area GDP to increase by only 0.9 per cent this year, compared with its December projection of 1.1 per cent.

“High uncertainty, both at home and abroad, is holding back investment and competitiveness challenges are weighing on exports,” Lagarde said on Thursday afternoon, adding that rate-setters were facing an acutely uncertain environment. Growth last year was a sluggish 0.7 per cent.

But Lagarde added that “an increase in defence and infrastructure spending could also add to growth” and “could also raise inflation through its effects on aggregate demand”.

Ahead of the ECB decision, Goldman Sachs economists wrote in a note to clients that Germany’s debt-funded push for much higher defence spending and infrastructure investment “clearly lowers the pressure” for the ECB to cut interest rates below 2 per cent.

The ECB also raised its forecast for inflation this year from its December estimate of 2.1 per cent to 2.3 per cent on the back of higher energy prices.

It added that “most measures of underlying inflation” suggested that it remained on track to meet its 2 per cent target.

Pooja Kumra, a rates strategist at TD Securities, said the ECB was “certainly more cautious” on future cuts, as she alluded to US President Donald Trump’s threatened tariffs on the EU.

“With uncertainty around fiscal [policy] and tariffs, they cannot commit to any path,” she said.

“We think if inflation and growth data come in line with expectations over the coming months, the ECB is likely to cut one more time to 2.25 per cent in April, before pausing in June when the fiscal and tariff impact becomes clearer,” said Neil Mehta, portfolio manager at RBC BlueBay Asset Management.

Source: Economy - ft.com