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The European Central Bank has issued a warning about challenges facing the Eurozone’s stalled economy as it reduces its reference interest rate by a quarter-point to 2.75 percent.
In a unanimous decision on Thursday, the ECB lowered the deposit rate to its lowest level since early 2023, following a report from Eurostat that revealed zero growth in the Eurozone economy in the fourth quarter of 2024.
Christine Lagarde, President of the ECB, cautioned that the economy is expected to remain weak in the short term. She noted that surveys indicate a continued decline in manufacturing despite growth in services. Lagarde stated, “Consumer confidence is fragile.”
She pointed out that economic risks lean towards the negative side, with potential trade frictions globally impacting the Eurozone economy, and reduced confidence possibly hindering investment and consumption.
Lagarde argued that the impact of tariffs on inflation or deflation is uncertain, but it is certain to have an overall negative effect on a global scale.
In a related statement, the ECB highlighted that the decline in inflation, dropping from a high of 10.6 percent in 2022 to 2.4 percent in December, is progressing as expected. The statement also mentioned that “the economy still faces headwinds.”
The central bank acknowledged that “monetary policy remains restrictive,” signifying that interest rates are still above the neutral rate that neither boosts nor restrains the economy.
Lagarde confirmed that the governing council did not even consider a half-point cut this month, contrary to the hopes of some economists until recently.
Following the meeting, the euro slightly strengthened by 0.1 percent against the dollar, reaching $1.043 for the day.
With the widely anticipated decision on Thursday, the ECB has now lowered rates five times since last summer. Post decision, swaps markets predicted two or three additional quarter-point reductions by year-end, consistent with earlier projections.
“Our view is that economic data will continue to push the ECB to cut at every meeting until the deposit rate reaches 1.5 percent,” said Tomasz Wieladek, chief European economist at asset manager T Rowe Price, predicting more cuts than the market consensus.
He cited the threat to Eurozone economic growth posed by US President Donald Trump’s tariff plans and the expected fall in inflation later in the year.
Lagarde stated that policymakers are facing “significant and probably rising uncertainty,” making it impossible to provide strong forward guidance.
She clarified that during the Thursday meeting, the governing council did not discuss “the point where we have to stop [cutting interest rates].” She emphasized that the direction of rate cuts will be based on data, including the sequence, speed, and extent of future reductions.
She argued that recent increases in longer-term Eurozone government borrowing costs were partially due to US market dynamics, but stressed that ECB cuts would still impact the Eurozone economy.
Despite the rate cuts, Germany’s 10-year bond yield, a Eurozone benchmark, has increased by nearly half a percentage point from its low in December to the current 2.51 percent. Bond yields move inversely to prices.
The ECB reiterated on Thursday that “gradually fading effects of restrictive monetary policy should stimulate demand over time,” pointing to rising real incomes and reduced borrowing costs.
“There is recovery… We never talked about stagflation,” Lagarde stated, highlighting that growth last year was double that of 2023, with a strong labor market.
However, the ECB projects only a slight growth acceleration from 0.7 percent in the previous year to 1.1 percent this year.
In contrast to the Eurozone’s slow progress, the US economy expanded at an annualized rate of 2.3 percent in the fourth quarter of last year, approximately 0.6 percent on a quarterly basis.
The ECB’s decision followed a day after the US Federal Reserve maintained its rates unchanged.
Investor expectations of more ECB rate cuts compared to the Fed have weakened the euro, nearing parity with the dollar.
“Currently the question is not if the ECB will continue to lower interest rates this year, but by how much,” wrote Ulrich Kater, chief economist at DekaBank, in a note to clients.
In a shift from previous hawkish language, the ECB dropped the commitment to “keep policy rates sufficiently restrictive for as long as necessary” to align inflation with the 2 percent target.
