ECB interest rate cuts in 2025: How low can they go?
The European Central Bank (ECB) is back in the spotlight for monetary easing, with markets and economists speculating on how far Frankfurt might go in cutting interest rates in 2025. After cutting the key deposit facility rate to 3 % in 2024, a full percentage point decline, economic and inflationary trends suggest that further reductions may be on the horizon. Could rates fall below the "neutral" 2% level, and what factors might prompt such a move?
The ECB's easing has been driven by falling inflation and weak growth. Eurozone annual inflation eased from 2.8% in January 2024 to 2.2% in November and economic growth slowed to an annual rate of 0.4% in the third quarter, edging closer to stagnation.
"After a long period of restrictive policies, our confidence that we are seeing a timely return to the [2%] target has increased," ECB President Christine Lagarde said in a recent speech in Vilnius. In its December monetary policy statement, the ECB notably dropped its commitment to keep rates "fairly restrictive for as long as necessary", signaling a clear shift towards a more accommodative stance. "This bias no longer reflects the evolving macroeconomic landscape, our outlook for inflation or the balance of risks around it," the ECB's Lagarde said.
The latest macroeconomic projections show slight downward revisions to inflation forecasts, with headline inflation expected to reach 2.1% and core inflation to 2.3% before both converge to 1.9% by 2026. Growth forecasts have also been revised downwards. lower, with 2021% now forecast at 11. from 1.3% in September and 2026 at 1.4% on down from 1.5% previously. The ECB appears poised to adjust its deposit facility rate to a so-called "neutral" level, a point widely seen as maintaining economic balance without stimulating or curbing growth.
Money markets are already pricing in a full percentage point rate cut by the ECB in 2025, which would bring the deposit facility rate to 2%, the lowest level since January 2023. “The ECB continues to prefer a gradual approach to its monetary relief. We expect rate cuts of 25 basis points at each future monetary policy meeting until the deposit facility rate stabilizes at 2.0% in June 2025,” Guillaume Derrien, economist at BNP Paribas, noted recently.
The argument that the ECB sees the neutral rate of 2% as the potential endpoint of its tapering cycle stems from the reality that monetary policy alone cannot always carry the burden of addressing the eurozone's economic challenges. Fiscal policy must also play its role. Katharine Neiss, PhD, chief European economist at PGIM Fixed Income, noted that the ECB's December meeting signaled that it may be near the end rather than the middle of its easing cycle. “For our part, we are maintaining our forecast for an additional 100 bps of policy rate cuts in 2025, which would take the deposit rate to 2.0%.
ECB President Christine Lagarde reinforced this balanced approach, stating that monetary policy decisions remain flexible and not set on a predetermined path. She also emphasized that the important economic challenges of the region cannot be solved by monetary policy alone, stressing that the ECB "cannot serve as a jack of all trades" for the European economy.
Veteran Wall Street analyst Ed Yardeni, president of Yardeni Research, echoed that view, calling on the European Union to act decisively on governance reforms and economic growth. He pointed to recommendations from former ECB chief Mario Draghi and former Italian prime minister Enrico Letta as critical steps to ensure the future stability of the bloc.
President-elect Donald Trump's promise to impose a 60% tariff on Chinese imports and a universal 10% tariff on all other countries looms large for the eurozone. Heavy European export industries, from machinery to pharmaceuticals, face significant risks from reduced global trade volumes.
Bank of America economist Ruben Segura Cayuela sees the ECB's shift from an aggressive stance to a dovish stance as a signal that more substantial cuts may be on the horizon. "We expect consecutive cuts from the ECB to a deposit rate of 1.5% by September," he said, adding that this forecast assumes worsening data and escalating risks from global trade tensions. "Risks of a faster tapering cycle are significant given the renewed uncertainty over trade policy and the fallout from tariffs."
Goldman Sachs economist Sven Jari Stehn also highlighted the potential for a faster pace of cuts depending on the economic outlook. "Given our forecast for low growth and a gradual decline in core inflation towards 2%, we anticipate a cut of 25 basis points in January, with a potential for 50 basis points in March." Goldman Sachs predicts successive cuts to bring the deposit rate to 1.75% by mid-2025, although Stehn noted the risk of "faster and deeper cuts" if conditions worsen.
Bill Diviney, head of macro research at ABN Amro, predicts that trade tariffs could be a disinflationary blow to the eurozone, pulling inflation further below the ECB's 2% target. “We expect the ECB to cut rates by 25bp at every Governing Council meeting next year, with the exception of a pause in April. Finally, we see the ECB cutting its deposit rate down to 1%.
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