ECB cuts rates in move to a dovish tilt

The European Central Bank (ECB) cut its policy rate today for the fourth time in this cycle, also marking its third consecutive cut. The interest rate on the main refinancing operations, the marginal lending facility, and the deposit facility were each lowered by 25 basis points to 3.15%, 3.40%, and 3.00%, respectively.

Although ECB President Christine Lagarde continued to avoid providing any solid forward-guidance, markets are expecting a further run of consecutive rate cuts over the coming few quarters, with a jumbo 50 bps rate cut now expected in January.

Recent developments

The ECB made notable dovish changes to its policy statement, dropping the references to restrictive policy settings and the need for inflation to return to target. Indeed, President Lagarde noted that these cuts signal their increased confidence on the future path of inflation, particularly in light of how much progress they’ve made in keeping policy restrictive.

That said, lingering wage pressures and sticky services inflation is giving them some pause around the inflation outlook, adding to still elevated levels of uncertainty. As a result, despite some discussion on a 50 bps rate cut, they deemed a 25 bps cut as the right call for this meeting. 

Moreover, while they continue to emphasise a data-dependent and meeting-by-meeting approach, their increasing focus on the downside risks to inflation suggests that the ECB will likely continue to recalibrate monetary policy to looser settings in the meetings ahead.

Finally, President Lagarde noted that they were looking through the temporary rebound in growth during the Q3 period—which was likely driven by the Paris Olympics—as underlying momentum remains relatively weak. There are also risks around potentially greater frictions to global trade amid U.S. president-elect Trump’s return to office, the impact of which have not yet been incorporated into any of the staff projections given their highly uncertain nature. Together with heightened geopolitical risks, growth risks remain tilted to the downside.

Forecast changes

The ECB published its updated full-year average staff projections and provided new projections for 2027. The GDP growth projection was revised lower over the next two years:

• 2025: 1.1% (downward revision from 1.3%)
• 2026: 1.4% (downward revision from 1.5%)
• 2027: 1.3%

The headline inflation outlook was revised slightly lower over the next two years:

• 2025: 2.1% (downward revision from 2.2%)
• 2026: 1.9% (downward revision from 1.9%)
• 2027: 2.1%

The core inflation outlook remained mostly unchanged, with a slight downward revision to 2026:

• 2025: 2.3% (unchanged)
• 2026: 1.9% (downward revision from 2.0%)
• 2027: 1.9%

Policy outlook

With the disinflationary process well on track and the underlying inflation trend consistent with the ECB’s 2% target over the medium-term, the ECB has continued to ease monetary policy settings in light of worsening economic conditions. While uncertainty on inflation continues, particularly as services inflation remains stubbornly elevated, risks have becoming increasingly two-sided.

President Lagarde specifically noted that the direction of travel for rates is “very clear,” likely suggesting additional rate cuts from here, though the pace and sizing will be ultimately determined by a data-dependent and meeting-by-meeting approach. Moreover, while there was no discussion on the neutral rate in this meeting, President Lagarde noted that this will likely be debated in future meetings as they get closer to where it eventually is.

Overall, the troubling state of the Euro area economy coupled with the staff’s downgraded outlook, suggest that the path forward calls for consecutive rate cuts through the first half of 2025—a far more aggressive pace of easing than the Federal Reserve.