ECB signals higher conviction in near-term cuts; beyond neutral is Trump-dependent

Specifically, in the policy statement’s reference to inflation, the ECB noted that despite high domestic price pressures, ‘wage growth is moderating as expected, and profits are partially buffering the impact on inflation’. This part was absent in the December statement, and suggests greater confidence in reaching the 2% inflation target.

So, it is clear that barring any large deviation in the data from its baseline, the ECB is taking rates back to neutral. Two key uncertainties then arise: 1) where exactly the Governing Council sees the neutral rate, and 2) whether rates will be cut below neutral. With regards 1) president Lagarde noted in the press conference that ECB staff will publish an updated assessment of where it sees neutral on 7 February, but Lagarde also hinted that the Governing Council would not mechanically adhere to the outcome of this, saying that it would ‘look out of the window’ as well (we read this to mean look at how lending and the broader economy is performing as a guide to whether rates are still restrictive or not). With regards 2) the elephant in the room is clearly trade tensions, and whether Trump will go ahead in significantly raising tariffs on European (and global) imports into the US. Here, Lagarde offered little further detail, noting the downside risks this posed to growth, but reverted to a more neutral message with regards inflation, merely stating that it would create ‘uncertainty’ over the outlook. This contrasts with more recent off-the-cuff remarks which suggested she saw more downside risks to inflation from tariffs (see here).

On both of these uncertainties, we continue to see reasons for the ECB going much further with rate cuts over the coming year. On neutral, we continue to peg it on the lower end of most estimates, at 1.5%. Furthermore, our base case sees the US ultimately raising trade tariffs significantly in the second half of 2025, driving a fall in eurozone exports to the US and putting the brakes on the recovery. We also think this will lead to a significant undershoot in the 2% target, via the hit to activity and to energy prices. In response to this slowdown and inflation undershoot, we see the ECB cutting the deposit rate back down to 1% by early 2026.