The European Central Bank (ECB) has cut its benchmark interest rate by 0.25 percentage points to 2.75%, marking its fifth rate cut since June in an effort to stimulate economic growth in the eurozone.
The rate cut was widely anticipated given stagnant economic activity and weak consumer confidence in Europe, according to Nicolas Forest, CIO at Candriam. With inflation nearing 2%, slowing wage growth, and tighter financial conditions for corporate loans and mortgages, Forest believes the ECB is likely to continue gradual rate cuts in the coming months. However, he noted that “the ECB remains stuck to its data-dependent, meeting-by-meeting approach, with no further guidance on cuts and no changes to its policy stance.
Forest also pointed to uncertainty about US trade policy, particularly the risk of potential tariffs under Donald Trump if he returns to office. “US tariffs and any subsequent retaliation would weigh on European growth and pose a risk to the disinflation trend,” he warned, adding that the Bank of Canada faced similar concerns, having cut rates but withheld guidance on future moves.
Looking ahead, Forest expects the March ECB meeting to be more significant, with fresh data and updated quarterly projections providing greater clarity. “With the cost of credit still high and weak economic prospects in Europe, we still expect three rate cuts this year, bringing the terminal rate to 2%, in line with market pricing,” he said, emphasising that the ECB should prioritise growth over inflation risks, unlike the US Federal Reserve.
Neil Hutchison, European liquidity strategies portfolio manager at J.P. Morgan Asset Management, echoed this sentiment, adding: “This move is all about supporting growth amid disinflation, offering some certainty for the Eurozone”. The political landscape, particularly with Donald Trump back in focus, makes it crucial to watch ECB President Christine Lagarde’s messaging, especially concerning potential US trade tariffs, according to Hutchison.
The ECB’s rate cut provides Central and Eastern European (CEE) central banks with greater room to ease policy without negatively impacting their exchange rates, but caution remains, according to Roger Mark, an analyst in the emerging market fixed income team at Ninety One. Mark noted that while the ECB’s move is generally “positive” for CEE central banks, their policies remain influenced by Federal Reserve decisions and the impact of a weaker euro on emerging market currencies.
ECB rate cut sparks consensus on further easing
In Czechia, the Czech National Bank is expected to resume rate cuts next week, likely lowering rates by 25 basis points to 3.75%, predicted Mark. However, further cuts will depend on whether services inflation slows enough to keep inflation targets within reach. In Hungary, the National Bank of Hungary (NBH) has taken a more cautious stance. “The hawkish tilt from NBH in recent months speaks not just to a complicated inflation picture on the back of strong wage growth, but also the sensitivity to forint weakness given the strong role of imported disinflation,” Mark explained. The ECB’s easing could support Hungary’s rate-cutting cycle later this year, but the bank remains wary of US-European monetary policy divergence, which could strengthen the US dollar and weaken the forint.
In Poland, Adam Glapiński, governor, National Bank of Poland (NBP), has suggested that cuts are unlikely before the presidential elections, despite pressure for monetary easing. “NBP having room to cut rates much this year remains in doubt, but continued ECB cuts could strengthen the zloty, easing imported inflation and opening the door for cuts in the second half of the year,” Mark added.
The rate cut aligns with its shift toward a more neutral policy stance, balancing weak economic growth and persistent inflationary pressures, according to Konstantin Veit, portfolio manager at Pimco.
Veit noted that since December, the ECB has moved away from a “sufficiently restrictive policy” and is now focused on delivering an “appropriate policy stance.” While ECB President Christine Lagarde did not specify a target rate in her announcement, Veit pointed out that she had previously mentioned a neutral policy range of 1.75-2.25% at the World Economic Forum held in Davos last week, suggesting that further rate reductions could be on the horizon.
Market expectations currently price a terminal rate of around 2%, which Veit described as “broadly consistent with our estimates for a neutral policy rate for the euro area” and reflective of a soft landing scenario. However, he warned that uncertainty remains around the exact neutral rate, and the ECB will likely take a “gradual approach” to further easing as inflationary pressures persist.
The pace and scale of future rate cuts will depend on economic data in the coming months, Veit added. While the ECB remains optimistic about stabilising growth, Pimco expects economic performance to be weaker than ECB projections, which could lead to markets pricing in an even lower terminal rate.
There’s speculation about how many more cuts are coming and how fast they will happen. For instance, David Zahn, head of European fixed income at Franklin Templeton, sees the potential for rates to go even lower, predicting a reduction to 1.5% by year-end. “The eurozone’s stagnant economy, with a Q4 2024 GDP growth of 0.0%, suggests a need for additional monetary easing. While inflation remains a concern, the economic slowdown is likely to take precedence. A more accommodative ECB should be supportive of European bonds, specifically the short end of the market.”
Roelof Salomons, chief investment strategist at BlackRock Investment Institute, on the other hand, expects the ECB to cut rates at each meeting until hitting 2% by summer, noting that “subdued growth and moderating inflation support further cuts” as the ECB targets a neutral rate. However, he warned that geopolitical risks, declining competitiveness, and political uncertainty could weigh on growth.
“On balance, we think growth is more likely to negatively surprise than positively,” Salomons shared, adding that this is “not a typical cutting cycle”. Inflation risks persist due to elevated wage growth and potential supply shocks, making the pace of easing uncertain.
Market expectations have shifted, now aligning with BlackRock’s forecast of a 2% terminal rate. Salomons remains neutral on long-term euro area government bonds, favouring short-dated bonds and credit for income. “We still favour US stocks over Europe’s on stronger corporate earnings but find opportunities in Europe at the sector and company level,” shared Salomons.
The ECB will be hoping its latest rate cut will help revive economic sentiment across the eurozone, according to Richard Carter, head of fixed interest research at Quilter Cheviot. Weak consumer confidence remains a major drag on the economy, with many households increasing savings despite wages outpacing inflation. “The economy is in desperate need of stimulus, and the ECB will be hoping that this fifth rate cut will begin to make a difference. Today’s news will at the very least bring some relief to consumers and businesses, potentially boosting confidence and aiding in the economic recovery,” said Carter.
The ECB’s next meeting in March will be closely watched as investors look for clearer signals on future rate cuts.
Source: Fund Europe
