The European Central Bank (ECB) has lowered borrowing costs by further quarter point (0.25 of a percentage point) as the looming threat of US tariffs and a surge in bond yields linked to a rearmament drive in Germany complicated the economic outlook.
It was the ECB’s sixth rate cut since last July but market commentators say it may be the last easy decision with so much uncertainty now coursing through the global economy.
Policymakers reduced the central bank’s main deposit rate to 2.50 per cent, a move that had been flagged in advance, but they were said to be increasingly split about the need to support Europe’s flagging economy with fresh figures showing the euro area economy unexpectedly contracted in the final quarter of 2024 and snuff out inflation, which remains stubbornly high in services sector.
The imminent threat of a trade war with the US and major changes to German and European Commission fiscal rules to boost defence spending also complicate matters.
The ECB has, in recent days, come under pressure to prevent a steep rise in euro zone government borrowing costs after the German chancellor-in-waiting, Friedrich Merz, said his country would “do whatever it takes” to rearm.
Price pressures across the euro zone eased in February with headline price growth softening to 2.4 per cent, from 2.5 per cent in January.
However, increases in energy prices in response to the uncertainty surrounding “peace talks” to end the Russian invasion of Ukraine pose a risk to the ECB inflation projections, which suggest inflation will hit the bank’s 2 per cent target by the first quarter of 2026.
“The disinflation process is well on track,” the ECB said in a statement accompanying the announcement. However, it upgraded the outlook for inflation slightly.
“Staff now see headline inflation averaging 2.3 per cent in 2025, 1.9 per cent in 2026 and 2.0 per cent in 2027. The upward revision in headline inflation for 2025 reflects stronger energy price dynamics,” it said.
Markets are factoring in at least two more rate cuts this year but the the focus will now turn to ECB president Christine Lagarde’s post-meeting comments and whether she continues to describe policy as “restrictive”.
“The ECB finds itself in a challenging position between the threat of US tariffs in the near-term that could warrant further policy rate cuts — and a move into stimulative territory – and the growing commitment to higher defence spending over the next several years which will be required to secure Europe’s strategic autonomy,” Mark Wall, chief European economist at Deutsche Bank, said.
“This environment requires a deft hand on the monetary policy lever and the preservation of policy optionality,” he said.
