The European Central Bank (ECB) is widely anticipated to lower interest rates by 25 basis points on Thursday, as inflation trends toward its 2% target and economic growth remains sluggish. The deposit facility rate is expected to decline from 3% to 2.75%, marking its lowest level since February 2023.
While the prevailing economic indicators justify easing monetary policy, potential US trade tariffs could introduce uncertainty for ECB policymakers, adding complexity to the rate-cutting trajectory.
Analysts Predict Further Rate Cuts in 2025
Market analysts foresee additional rate cuts in the coming year. Goldman Sachs economist Sven Jari Stehn expects another 25 basis point reduction at the ECB’s March meeting, with further cuts likely as economic conditions evolve.
“We maintain our forecast for sequential cuts to 1.75% in July, given our projection of subdued growth,” Stehn said. ING analyst Francesco Pesole echoed this sentiment, stating that a “broadly dovish message” from the ECB could pave the way for further rate reductions in the eurozone.
Bank of America predicts rate cuts in both January and March, with a potential terminal rate of 1.5% or lower, increasing the monetary policy divergence with the US Federal Reserve. However, some analysts caution that delays beyond March may occur due to core inflation volatility.
ECB policymakers speaking at the World Economic Forum in Davos acknowledged that inflation risks are diverging between the US and the eurozone, with European inflation appearing less severe. None of the ECB speakers highlighted inflation risks arising from recent energy price movements.
Projections for euro area economic growth remain modest, with Bank of America forecasting fourth-quarter growth at 0.1% quarter-on-quarter. Spain is expected to lead (0.5%), followed by Italy (0.2%), while France (-0.1%) and Germany (0.0%) continue to struggle.
Trade Tariffs Introduce New Risks
ECB President Christine Lagarde is likely to face questions during Thursday’s press conference regarding the potential impact of US tariffs on the European economy.
Reports indicate that US Treasury Secretary Scott Bessent is preparing a 2.5% universal tariff, with gradual monthly increases up to 20%. President Donald Trump has signaled support for more aggressive tariffs on key goods, including steel, copper, and semiconductor chips.
News of these trade measures has already impacted currency markets. After briefly strengthening above 1.05 against the dollar, the euro fell to 1.0430 as tariff concerns emerged. “Volatility is likely to continue, and in the short term, the tariff noise is a key driver,” noted BBVA in a Tuesday report.
Tariffs and ECB Policy Outlook
Higher US tariffs on European imports could weigh on eurozone growth, particularly in sectors like machinery and pharmaceuticals, which rely on US exports. In theory, this could reinforce the case for lower interest rates.
However, the inflationary impact of tariffs remains uncertain. If the EU retaliates against US products, or if a weaker euro raises import costs, inflation could rise instead. Banque de France Governor François Villeroy de Galhau downplayed these risks, stating at Davos that US tariffs may drive inflation in the US but would have limited impact on the eurozone.
ABN Amro economist Bill Diviney suggested that tariffs may ultimately have a deflationary effect in Europe due to weakened global trade and lower commodity prices. “This is an important factor behind our view that the ECB policy rate will eventually be reduced to 1%,” he said.
As the ECB prepares to announce its decision, investors and policymakers will closely monitor economic data and geopolitical developments to gauge the long-term implications for monetary policy.
