On Thursday, January 30, the European Central Bank (ECB) made a significant policy adjustment by lowering interest rates by 25 basis points to 2.75%. This marks the fifth rate cut since the commencement of the easing cycle in June 2024. As a result, the euro showed slight weakness against the US dollar, approaching the 1.04 mark, while the Stoxx 600 index across Europe maintained a modest gain of 0.6%.
The deposit facility rate in the Eurozone stands at 2.75%, aligning with market expectations and down from a previous value of 3%. Similarly, the marginal lending rate has been revised to 3.15% from the earlier 3.4%, with current refinancing rates set at 2.9%, down from 3.15% previously. These adjustments reflect the central bank's ongoing strategy to support the economy amid various challenges.
The policy statement released by the ECB was notably similar to that of December last year, reiterating the bank's readiness to adjust all monetary instruments without committing to a specific interest rate trajectory ahead of time. The bank's decisions will be based on incoming data, with the expectation of conducting rate assessments at each meeting.
Analysts have highlighted that this recent declaration underscores the ECB's assertion that "current monetary policy remains restrictive." Furthermore, it acknowledges that "the Eurozone economy still faces challenges," which hints at the likelihood of more easing measures being on the horizon. Traders are maintaining their expectations for an additional 70 basis points cut this year, anticipating a policy rate to settle around 2%, placing it within the neutral rate range identified by many analysts, typically between 2% and 2.25%.
The statement also reveals that the decision to continue with rate cuts is grounded in the latest evaluation of inflation outlooks, core inflation dynamics, and the transmission strength of monetary policy. The ECB's assessment of inflation remains consistent with its previous communications, stating that the "disinflation process is progressing smoothly," and expectations hold that inflation will reach the bank's medium-term target of 2% by 2025. Most core inflation metrics indicate stability around this target.
Despite these optimistic projections, the statement acknowledges that inflation remains relatively high across European nations, primarily due to specific sectors still adjusting to past surges in inflation. This adjustment phenomenon has a considerable lag but is expected to stabilize over time. Wage growth is projected to slow as anticipated, with real income increases and the diminishing effects of prior restrictive monetary policies likely to support a gradual recovery in demand.
Regarding the traditional Asset Purchase Program (APP) and the pandemic-era Pandemic Emergency Purchase Programme (PEPP), the ECB noted that, in light of ceasing reinvestment of the principal on maturing securities, both borrowing programs are unwinding in a controlled and predictable manner.
Market analysts have pointed out that the futures market shows significantly greater bets on rate reductions by the ECB throughout the year when compared to the expectations for cuts by the U.S. Federal Reserve. This divergence suggests a potential split in monetary policy directions between the two major central banks, reflecting more profound economic issues being faced in Europe. The focus of ECB President Christine Lagarde's press conference pivoted toward these pressing concerns.
Further insights were provided by the latest economic data released on the same Thursday, corroborating the ECB's apprehension regarding the subdued growth across Europe. The preliminary Gross Domestic Product (GDP) figures for the Eurozone in the last quarter of the previous year indicated zero growth quarter-on-quarter, falling short of a projected increase of 0.1% and significantly lower than the 0.4% growth recorded in the third quarter. Notably, Germany, often considered the economic engine of Europe, experienced a larger-than-expected contraction of -0.2% in the fourth quarter, compounded by weak exports. France, the second-largest economy in the region, also saw a slight decline of 0.1% in GDP during the same period, both falling below market forecasts, thus continuing to suppress European bond yields.
Some analysts have speculated that the ECB's commitment to ongoing rate cuts serves as a deliberate strategy to mitigate the impact of recent inflation trends pushing above the 2% target. In December, the nominal inflation rates in the Eurozone rose for the third consecutive month to 2.4%. The ECB considers this upward trend as a fading effect from decreasing energy prices and anticipates a return to the 2% target beginning in the second quarter of the current year, being far more concerned about the sluggish economic landscape.
According to Sphia Salim, the European Rates Research Head at Bank of America Global Research, market attention was keenly directed towards Lagarde's press conference, particularly concerning how the ECB interprets recent commentary on rising energy prices and their response to uncertainties surrounding U.S. tariffs.
The U.S. President has repeatedly threatened to impose tariffs on goods imported from Europe. Lagarde indicated to the media last week that Europe must be "prepared" for any potential trade tariffs. She remarked that it was "very wise" for the U.S. President not to implement comprehensive tariffs on the first day of his presidency, as such measures may not yield the anticipated outcomes. Consequently, she projected that any future tariffs would be "more selective and targeted."