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The European Central Bank has warned of “headwinds” to the Eurozone’s stagnating economy as it cut its benchmark interest rate by a quarter-point to 2.75 per cent.
Thursday’s unanimous decision, which takes the ECB’s deposit rate to its lowest level since early 2023, came hours after Eurostat reported that the Eurozone economy had not grown at all in the fourth quarter of 2024.
ECB president Christine Lagarde cautioned that the economy was “set to remain weak in the near term”, adding that surveys pointed to a continued contraction in manufacturing even as services grow. “Consumer confidence is fragile,” she said.
She argued that economic risks were “tilted to the downside”, since greater frictions to global trade could weigh on the Eurozone economy while lower confidence might be a drag on investment and consumption.
The ECB chief argued that, while it was not easy to know whether tariffs would be inflationary or deflationary, “all we know for sure is it will have a global negative impact”.
In a statement accompanying the decision, the ECB maintained that the fall in inflation, which has tumbled from a 2022 peak of 10.6 per cent to 2.4 per cent in December, was “well on track”, while noting that “the economy is still facing headwinds”.
The central bank added that “monetary policy remains restrictive” — an acknowledgment that interest rates are still higher than the neutral rate that neither stimulates nor holds back the economy.
Lagarde said the ECB’s governing council did not even discuss the possibility of a half-point cut this month — an option some economists had hoped for until a few weeks ago.
The euro slightly strengthened following the meeting, up 0.1 per cent on the day against the dollar at $1.043.
With Thursday’s widely-expected decision, the ECB has now cut rates five times since last summer. In trading immediately afterwards, swaps markets were pricing in two or three more quarter-point reductions by the end of the year, unchanged from earlier in the day.
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“Our view is that economic data will continue to push the ECB to cut at every meeting until the deposit rate reaches 1.5 per cent,” said Tomasz Wieladek, chief European economist at asset manager T Rowe Price, predicting more cuts than the market consensus.
He cited the threat to Eurozone economic growth posed by US President Donald Trump’s tariff plans and the expected fall in inflation later in the year.
Lagarde said that, with policymakers facing “significant and probably rising uncertainty”, it was not possible to give firm forward guidance.
She added that the governing council did not have any discussion “about the point where we have to stop (cutting interest rates)” during its meeting on Thursday.
“We know the direction of travel, this is the direction we will take,” she said, maintaining that the sequence, pace and magnitude of further cuts would be data-driven.
She argued that recent increases in longer-term Eurozone government borrowing costs were partly due to market movements in the US, but insisted that the ECB cuts would still have an effect on the Eurozone economy.
Despite the cuts, Germany’s 10-year bond yield, a benchmark for the Eurozone, is up almost half a percentage point from its December low to the current 2.51 per cent. Yields move inversely to prices.
On Thursday the ECB reiterated that “the gradually fading effects of restrictive monetary policy should support a pick-up in demand over time”, pointing to increases in real incomes and lower borrowing costs.
“There is recovery . . . We never talked about stagflation,” Lagarde said, noting that last year’s growth had been double that of 2023 and that the labour market was strong.
However, the ECB predicts only a slight acceleration in growth from 0.7 per cent for last year as a whole to 1.1 per cent this year.
By contrast with the Eurozone’s sluggish progress, the US economy expanded at an annualised rate of 2.3 per cent in the fourth quarter of last year, equivalent to a quarterly rate of around 0.6 per cent.
The ECB’s decision came a day after the US Federal Reserve kept rates on hold.
Investor expectations that it will cut rates more than the Fed this year have weakened the euro, which has come close to parity to the dollar.
“Currently the question is not if the ECB will continue to lower interest rates this year, but by how much,” wrote Ulrich Kater, chief economist at DekaBank, in a note to clients.
In a shift from previous hawkish language, in December the ECB dropped a commitment to “keep policy rates sufficiently restrictive for as long as necessary” to bring down inflation in line with its 2 per cent target.
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