SGH Insight
The European Central Bank will cut 25bp, from 3% to 2.75% on its benchmark deposit facility rate, when the Governing Council convenes this week in Frankfurt.
While preserving the flexibility of its “meeting by meeting” approach to rate decisions, President Christine Lagarde will affirm what markets already know, that this is not the last rate cut, and that more cuts are likely to follow.
The cadence and final destination for rates will be left open, but we continue to expect the ECB to cut rates by 25bp at every meeting – Jan, Mar, Apr, Jun – until the deposit rate hits 2% in June (see also SGH 1/15/25, “ECB: Shifting Balance of Risks”).
Putting exogenous forces for a moment to the side, market expectations of ECB rate cuts have also pulled back of course by a backup since December in rate cut expectations by the US Federal Reserve. Furthermore, markets have put great weight on the assessment by Executive Board Member Isabel Schnabel that the nominal neutral rate for the euro area economy lies well north of 2%, and so by extension any cuts below 2.5% will be delivered much more cautiously, feeding into the narrative of an April meeting skip.
While she is extremely influential, Schnabel’s assessment of a significantly higher than 2% neutral rate is not shared more broadly across the Governing Council, and ECB.
Indeed, in an interview last week in Davos, Lagarde pegged neutral as probably somewhere between 1.75% and 2.25%. From Lagarde:
You know, the [ECB] teams do as much work as they can to pin it [neutral] down within a range that is as reduced as possible. At the moment, it’s anything between, you know, 1.75, and 2.25, people will be discussing that at length. When we get closer to that, it will, the debate will be a little bit hotter, but it’s that very, very subtle point where our monetary policy neither stimulates nor restricts, and it’s, it’s a touch and go.
Market Validation
Bloomberg 1/30/25
The European Central Bank lowered borrowing costs for a fifth time since June, with the region’s economy stalling and the 2% inflation target in reach.
Officials reduced the deposit rate by a quarter-point to 2.75% — as predicted by all analysts in a Bloomberg poll. They continued to describe their current monetary-policy stance as “restrictive,” signaling more loosening is in the pipeline, while reiterating that they’re not pre-committing to a particular rate path.
“We know the direction of travel,” President Christine Lagarde said, describing Thursday’s decision as unanimous. “For those who would like to have this solid forward guidance, it would be totally unrealistic to do anything of that nature, simply because we are facing significant and probably rising uncertainty at the moment.”
Bloomberg 1/30/25
German bond yields slumped as traders upped bets on interest-rate cuts from the European Central Bank this year, after policymakers lowered borrowing costs as expected and described their current monetary policy stance as restrictive.
Yields on two-year bunds fell as much as 10 basis points to 2.18%, the biggest drop in two months. Traders moved to price an additional 73 basis points of rate reductions from the ECB by year-end, up from around 65 basis points ahead of the decision.
Bloomberg 2/7/25
Economists at the European Central Bank said
the neutral rate of interest, a concept that may help determine
where cuts in borrowing costs will end, is probably between
1.75% and 2.25%.