The European Central Bank cut its key deposit rate by another quarter-point to 2 percent, as fading inflation gives it the freedom to support an economy burdened by U.S. President Donald Trump’s trade war.
The cut had been almost universally expected, after policy-makers signalled ahead of time that they would remain on an easing path that has seen them cut rates eight times in the last year.
“Most measures of underlying inflation suggest that inflation will settle at around the Governing Council’s 2 percent medium-term target on a sustained basis,” the ECB said in a statement while warning of “exceptional uncertainty.”
Taking down interest rates to a level at which they are longer hold back economic activity was easy enough, at a time when unpredictable U.S. policies and a war raging on the currency union’s borders were casting a long shadow. From here on, however, decisions will get much harder, economists warned, given that some disruption of global supply chains is becoming more likely as the trade war drags on.
The ECB’s staff cut their inflation forecasts for 2025 to show it right at the 2 percent target, down from 2.3 percent three months ago. Staff now expect it to dip to 1.6 percent in 2026 before returning to 2 percent in 2027. The growth outlook has remained largely unchanged, with forecasts of 0.9 percent next year, 1.1 percent in 2026 and 1.3 percent in 2027.
But as JPMorgan economist Greg Fuzesi sees it, the forecasts should be seen as “work in progress given the huge uncertainty over U.S. trade policy and the limited clarity so far on fiscal policy in Germany and the rest of the region.”
Germany’s new government has indicated it will try to cushion the shock from the trade war with new debt-financed programs to boost domestic infrastructure and defense spending. While recent data have suggested this is starting to support activity, most analysts expect them to take time before having a meaningful impact on growth.
Further complicating the ECB’s task is that the current economic weakness may push inflation down below target in the near-term while a fiscal spending boost and possible tariffs could push up prices down the line. Given the lag with which monetary policy works, setting the right policy at the right time may prove exceptionally challenging.
While most analysts expect more interest rate cuts later in the year, the timing and scope remains uncertain. The policy statement offered little guidance, simply affirming “especially in current conditions of exceptional uncertainty, it will follow a data-dependent and meeting-by-meeting approach” and “is not pre-committing to a particular rate path.”
Financial markets will be closely monitoring the press conference of ECB President Christine Lagarde — who may have to face questions regarding her own future as well as the Bank’s — at 14:45 CET.
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