Central Bank Satisfied with Slight Reduction in Interest Rate
Going Easy on Eurozone: The ECB's Monetary Policy Shifts
The European Central Bank (ECB) has thrown a lifeline to the sluggish eurozone, making its fourth interest rate cut of the year and edging closer to the so-called 'neutral' rate level. In a move set to loosen monetary policy, the key deposit rate was slashed by 25 basis points to 3%, with the policy rate now down a full percentage point since June.
Despite the cut, the ECB's monetary policy still appears restraining, impeding economic growth and, in turn, inflation in the eurozone. But with a gloomier outlook for the eurozone economy and stalled progress against inflation, the bank might soon abandon its constrictive policy stance.
The ECB now predicts a lower inflation rate in 2025, with inflation expected to average 2.1% next year—a drop from the previous forecast of 2.2%. In 2026, inflation is projected to be 1.9%, much like the earlier outlook. This is the first time the ECB has included a forecast for 2027, with the inflation rate predicted to remain steady at 2.1%.
ECB economists also anticipate core inflation—an indicator of underlying price pressure—to be 2.3% in 2025 and 1.9% in 2026. In 2027, core inflation is expected to remain at the same level of 1.9%.
The bank is less optimistic about the eurozone's economic development, forecasting real GDP growth for the eurozone at 1.1% for 2025—a decline from the previous prediction of 1.3%. For 2026, the forecast has been adjusted down by 0.1 percentage points to 1.4%.
Tensions over inflation dynamics
Recent weeks and months have seen council members of the ECB suggest a 50 basis point interest rate cut for December. At one point, investors almost anticipated such a move on the money market. But in the days before the ECB's silence period, ECB board member Isabel Schnabel poured cold water on these expectations, arguing that the risk of inflation dipping below the ECB's 2% target in the medium term remains low.
Though not all ECB council members share this view. Governors of Italy and Portugal have long argued that monetary policy is too constrictive given the eurozone's economic situation. In recent statements, their French counterpart François Villeroy de Galhau and ECB Chief Economist Philip Lane have expressed concerns over the risk of underection the inflation target in the medium term. "Taking a cautious stance in December is premature, considering the current situation. We should keep the extent of the cut open, depending on incoming data, economic forecasts, and our risk assessment," Villeroy de Galhau said.
The extent of the ECB's accommodation in 2025 remains uncertain
Following the ECB's last interest rate decision of the year, experts are assessing the bank's monetary policy for 2025. Multiple interest rate cuts by the central bank in the coming months seem likely without an unexpected inflation shock. But opinions differ within the ECB Council and among analysts regarding the extent and pace of monetary policy adjustments.
One topic of debate is whether the ECB should lower interest rates below the neutral level next year—and where this neutral level is situated. With estimates ranging from 1.5% to just below 3%, most experts place it in the 2 to 2.5% range.
The ECB's decision could be influenced by economic policy in the US and its impact on inflation in the Eurozone. However, there are several uncertainties regarding Trump's economic policy and how it would affect the Eurozone. A trade war could restrict global economic growth, pushing inflation lower in the export-oriented eurozone, while some argue Trump's trade policy may boost inflation in the Eurozone due to higher import prices and inflationary pressures.
Businesses in the eurozone might benefit from the ECB's loosened monetary policy, as lower interest rates could stimulate investment and economic growth. The ECB's anticipation of lower inflation rates in 2025 and afterwards might lead to changes in financing strategies for businesses, considering potential adjustments in the bank's monetary policy in the coming year.
