Update
ECB post-meeting comment: Four cuts cover a lot of ground
The ECB implemented its fourth 25bp cut, taking the deposit rate to 3.00%. The policy statement was slightly more dovish, reflecting a somewhat weaker growth outlook and increasing confidence that inflation is converging to the central bank’s target. Looking ahead, Lagarde dampened market expectations somewhat, suggesting that a lot of ground has already been covered with the rate cuts to date.
Summary
Policy decisions
A lot of ground has been covered with four cuts
The 25bp cut was widely expected. Some policymakers proposed to possibly consider 50bp, but that did not find broader support.
It is not surprising that some policymakers wanted to discuss such a bigger move. After all, they had flagged this in advance. However, as we noted prior to the meeting, this was a minority and it was very unlikely that such a proposal would find support in the broader Governing Council.
Dropping the hawkish bias
The updated language read slightly more dovish than prior policy statements. The ECB no longer states that it “will keep policy rates sufficiently restrictive” in order to achieve the inflation aim. Arguably, this could indicate that policymakers believe that monetary policy is getting closer to neutral. However, the Governing Council did not make this change to signal that rates are no longer restrictive. Elsewhere, they still note that monetary policy remains restrictive – although financing conditions are easing.
So, instead, we believe the change reflects less of a hawkish bias in the Governing Council. Concerns about the economic outlook have increased. And even though the new staff projections are less pessimistic than some policymakers seem to be, the ECB sees inflation risks becoming more two-sided.
That’s also reflected in other parts of the statement, such as the Council’s conclusion that “most measures of underlying inflation suggest that inflation will settle at around the 2% target on a sustained basis.” This sustainable convergence has always been one of the requirements to dial the stance of monetary policy back from restrictive to neutral.
Neutral is in the low 2% range?
At the same time, President Lagarde hinted that the market may have been pricing somewhat too many rate cuts heading into the meeting. The ECB President noted that “a lot of ground has been covered” by the four rate cuts to date. And although the ECB did not discuss the neutral rate, Lagarde recounted that the conventional wisdom is that the neutral rate has risen somewhat. She recalled that ECB staff calculated that the neutral rate probably lies somewhere between 1.75% and 2.50%. This is broadly in line with our own calculations (table 2), but it is at the upper end of money market pricing prior to the press conference.
Lagarde added that discussions about the neutral rate will probably follow when the ECB gets closer to where it ultimately is. Or, as we noted going into today’s meeting, policy rates are still in restrictive territory, so there will be little opposition to gradual rate cuts as the risks to the inflation outlook become more balanced. However, as the policy rate approaches that neutral range, we expect more discord on the appropriate way forward. Two more rate cuts are sufficient to reach the upper bound of the range, so we would expect to see opinions diverge more starting in March or April.
Outlook: two-sided risks, and more uncertainty
The ECB’s updated staff projections show a picture of price stability. This supports today’s decision and some further rate cuts to neutral. However, uncertainty remains high, and not all risks are accounted for in the economic figures.
As widely expected, the ECB’s economists have downgraded their growth outlook for the coming two years. Lagarde summarized that the economy is losing momentum. The ECB still expects growth to pick up in the coming year, driven by household consumption and, subsequently, investment spending. However, this pickup is now seen to be slower than before.
Owing to the weaker growth outlook, the inflation forecasts were revised down marginally. President Lagarde added that measures of underlying inflation are developing in line with a sustained return to target, and she saw wages, profits, and profitability all heading in the right direction over the course of next year. She concluded that the ECB now expects inflation to converge with the central bank’s target slightly earlier in 2025 than they had expected before. That said, the staff projections still forecast 2% to be reached only by Q4.
Mission not yet accomplished
Yet, she also spoke some words of caution. Lagarde recounted that domestic inflation eased somewhat in October, but she added that it remains high at 4.2%. This mainly reflects the catch-up of wages and delayed price adjustments in some services sectors. So, the ECB is getting more confident, but some risks remain. As the ECB president concluded, “It is not yet mission accomplished. We are close, but we are not yet done.”
The risks unaccounted for
Additionally, Lagarde repeatedly expressed the heightened uncertainty brought about by domestic politics, and particularly the policies of the incoming US administration.
The ECB president confirmed that this uncertainty is not included in the latest staff projections. There is too much uncertainty, too much “distance between words and actions taken”, to account for this. Nonetheless, Lagarde’s personal take on the potential impact of new barriers to trade was interesting. She noted that trade restrictions are not conducive to growth, but she refused to list them as a clear upside or downside inflation risk – although she conceded that in the near term it would probably be inflationary.
Indeed, our own inflation forecasts already do account for the expected impact of Trump’s policies (or, a plausible interpretation of his agenda). According to our econometric models, the impact on growth should be fairly limited – and the recent slide in EUR/USD effectively mitigates the impact of any tariffs on European exports. However, virtually all of the inflation overshoot we forecast for 2026 can be traced back to the impact of the president-elect’s policies and Europe’s response. That’s especially the case if Europe retaliates with tariffs against the US, or if Europe is forced to increase anti-dumping measures against, e.g., China.
This uncertainty is another reason for the ECB to be cautious in the months ahead, and it is largely the reason we expect the ECB to pause in April at a rate of 2.25%.