We now know the European Central Bank’s rate cut plans

The European Central Bank made the long-awaited quarter-point cut in interest rates this week, and with the announcement came several signs that rates will quickly fall further early next year.

ECB President Christine Lagarde noted during her Thursday press conference that policymakers meeting in Frankfurt did not believe the fight against inflation is completely over and that services inflation remains a concern.

Overall, however, it was the most dovish meeting of the current cycle, not least because the ECB’s new macroeconomic projections predicted lower rates of inflation and economic growth for both this year and next.

Economists were also enthusiastic about removing the ECB’s message that the central bank should “keep interest rates sufficiently restrictive for as long as necessary.” Lagarde emphasized that there were downside risks to the euro zone’s already weak growth prospects, but said the inflation outlook had improved significantly and included upside risks. He also said that a larger cut, of half a point, had been discussed and that members of the Governing Council (GC) voted unanimously in favor of reducing rates.

Meanwhile, the ECB’s new staff forecast puts average headline inflation just above the target at 2.1% in 2025, with stronger price increases expected early in the year, suggesting it could fall below of the target later in the year.

The dovish turn was emphasized on Friday when Austrian central bank chief Robert Holzmann, widely perceived as the ECB’s arch hawk and the only Governing Council member to vote to hold rates instead of cutting them in June, told journalists that there would be no danger in cutting them. rates next year if the economy progresses as expected, according to Reuters.

Where is neutral?

Holzmann also said markets had a “central bank-like assessment” that interest rates will fall towards a neutral level – when monetary policy is balanced between boosting and restricting growth – of around 2% next year. .

The ECB on Thursday cut the deposit facility (its key rate) to 3%.

What constitutes the neutral rate has been a key point of debate in recent months, and Lagarde said on Thursday that while it had not been discussed at the December meeting, staff saw it between 1.75% and 2.5%. .

Another question for market participants is whether the ECB will take rates below this neutral level if inflation cools further and growth prospects deteriorate, as has happened. floated by the governor of the central bank of France, Francois Villeroy de Galhau.

This week’s messaging has largely confirmed existing market bets on the ECB’s 2025 rate cut plan.

According to LSEG data, money markets continue to price in a drop in the ECB’s key rate to 1.75% by September next year, with a hold beyond that figure.

But some analysts said there was now support for rate cuts that go beyond that.

Economists at Deutsche Bank said in a note on Friday that the ECB was on track to achieve subneutral rates in 2025, given the trend toward weak growth and below-target inflation.

They added that their base outlook was for a 1.5% rate by the end of 2025 via quarter-point cuts, but that a half-point move remained possible.

Dean Turner, chief euro zone economist and British economist at UBS Global Wealth Management, stopped his forecast at a 2% rate in June, but said risks were now “tilted towards the ECB having to do more, not less.” , to support the economy in 2025,” which will likely mean more cuts later in the year rather than bigger changes earlier in the year.

However, Kamil Kovar, senior economist at Moody’s Analytics, argued in a note that persistent core inflation would continue to spur ECB caution next year.

“We believe that after March, the battle over how far to lower rates will begin in earnest. We have no cut in April and the last cut in June, leaving rates at 2.25%,” Kovar said.