As was widely expected, the European Central Bank (ECB) decided to cut interest rates for the second time in this cycle, reducing the interest rate on the deposit facility by 25 basis points (bps) to 3.5% today, while rates on the main refinancing operations and the marginal lending facility were decreased to 3.65% and 3.90%, respectively. ECB President Christine Lagarde provided no forward guidance, once again emphasizing data dependence—although the new ECB staff forecasts showing a slight increase in core inflation, coupled with repeated mention of sticky domestic inflation, mean that back-to-back rate cuts are unlikely in the near-term.
Recent developments
With markets ramping up expectations for consecutive U.S. Federal Reserve rate cuts, investors have questioned if the ECB (and other developed market central banks) will follow suit. Certainly, with euro area growth disappointing of late, particularly Germany’s activity data and business confidence, some may argue that the ECB should be embracing a more aggressive rate cutting path.
Yet, sticky core inflation is still a cause for concern, and the trend of underlying domestic inflation remains unsatisfactory, as wage growth keeps services inflation particularly elevated. Against that backdrop, the ECB appears to be more in favor of a more gradual approach despite the downside growth risks.
ECB President Lagarde did acknowledge that inflation progress is being made. Labor costs have continued to moderate for a fourth consecutive month in June, and the combination of profits and productivity should begin buffering the impact of wage pressures on prices. Policymakers expect a return to 2% inflation before year-end 2025, but inherent risks and uncertainty around the outlook are keeping policymakers cautious and flexible.
Forecast changes
The ECB published its updated full-year average staff projections. The GDP growth projection was revised slightly lower for each year over the forecast horizon:
- 2024: 0.8% (downward revision from 0.9% in June)
- 2025: 1.3% (downward revision from 1.4%)
- 2026: 1.5% (downward revision from 1.6%)
The headline inflation outlook remained unchanged across the forecast horizon: 0.8% in 2024, 1.3% in 2025, and 1.5% in 2026. However, there was a slight upward revision to the core inflation forecast:
- 2024: 2.9% (increase from 2.8% in June)
- 2025: 2.3% (increase from 2.2%)
- 2026: 2% (unchanged)
