The sequence of events is as follows. This Thursday the European Central Bank (ECB) cut interest rates by 25 basis points, acknowledged that it had discussed a possible cut of 50 basis points and removed a key phrase from his statement (“we will keep official interest rates sufficiently restrictive for as long as necessary to achieve the inflation objective”). The last two events led investors to a completely dovish interpretation of the meeting and to fully discount a ‘jumbo’ rate cut (50 bp) for January. Within a few hours, the prominent American financial news agency Bloomberg published an exclusive: From the ECB itself they leak that there will be two cuts of 25 basis points in January and March. This Friday morning, investors have gone from discounting a drop of 50 bp to one of 38 bp (not enough to reach two ‘standard’ cuts). What happened in the middle and why has the ECB come out in a certain way to appease the market euphoria?
Hugo Le Damany and François Cabau, economists at AXA IM, believe that the message conveyed by the central bank admitting to having discussed the ‘jumbo’ cut and, above all, having eliminated that sentence in its statement, was a “unnecessary” way to complicate your life. “While we expected a simple modification, the Governing Council of the ECB decided to completely eliminate the forward guidance, which generated unnecessary uncertainty in our opinion,” they write this Friday in a note to clients. “Initially, the market took the removal of the mention as a moderate signal, but we are not sure that it is such a clear cut,” they add.
The majority of analysts consider that the ECB will have to cut rates more quickly and deeply than the Eurobank itself is telegraphing. The growth prospects are not good and those projected by the supervisor this Thursday, with a growth of 1.1% in the eurozone by 2025, are too optimistic, according to many analysts. “In particular, the forecast for 2025 seems very optimistic, since The ECB has not taken Trump or France into account and continues to bet on a return of the consumer. At first glance, these forecasts even seem like a scenario Goldilocks. Too good to be true,” Carsten Brzeski, an ING analyst, said yesterday.
In the analysis departments of prominent firms such as Pimco either Fidelity believe that the worsening economic outlook in Europe may force policymakers to cut interest rates more than the market expectswhich discounts a terminal rate of 1.75% in the deposit rate (right now at 3%, this is the rate at which the cycle of declines will be completed. The market “continues to be somewhat more hawkish than what we expected,” says Salman Ahmed, global head of macroeconomics and strategic asset allocation at Fidelity. There are “risks that the ECB will cut further if downside risks materialize,” he adds. “We believe growth will continue to be more weaker than the ECB expects and we see potential for markets to incorporate lower terminal rates,” says Konstantin Veit, portfolio manager at Pimco.
The danger of continuing to look back
So why the ECB surprised with that leak to Bloomberg? The team of strategists for Europe at Bank of America (BofA), headed by the Spaniard Rubén Segura Cayuela, argues in a note for clients published this Friday that the central bank is still too attentive to looking in the “rearview mirror” and that is why it does not act as fast as the context demands.
To the question of whether the reasons for the ECB to cut rates more quickly are not sufficiently well-founded, these strategists respond: “For us, yes. But the ECB still thinks that it is necessary to act with caution, given the current situation of inflation in services and wages. Little by little, the ECB is looking more to the future, but it has not yet done so completely. Keep looking in the rearview mirror, with a very big eye“Extending the metaphor, the ECB has been like an insecure driver who is constantly looking in the rearview mirror to interpret past signals, instead of looking ahead with confidence.
“Perhaps the main reason for policymakers’ caution is that domestic inflation (which leaves out the goods most linked to imports) remains above 4%. But, as President Lagarde noted at the press conference, that partly reflects the fact that prices in certain sectors are still adjusting to the inflationary surge of the past. This is certainly true in the case of insurance inflation, for example,” completes the photograph Jack Allen Reynolds, analyst at Capital Economics. The expert highlights two facts that show that the ECB may be looking too much in the rearview mirror: “The first is that surveys show that service companies’ sales price expectations have continued to fall. The second is that domestic inflation has historically been higher than other measures of underlying inflation.”
BofA highlights the fact that the much-discussed modification in the statement leaves open the possibility that rates could be below neutral level (the ideal level to avoid damaging or overheating the economy), if the updated economic forecasts are met. And the ECB’s projections for inflation also support this interpretation. The bank forecasts underlying inflation of 1.9% in 2026 and 2027, and general inflation of 2% on average for those years. “This is equivalent to a quasi-support for the market price, which estimates a terminal rate of around 1.8%,” point out BofA analysts.
Despite this, the American bank projects that the ECB will continue with gradual cuts of 25 basis points per meetingreaching a terminal rate of 1.5% in September 2025, adding that “the data will have to deteriorate further for the ECB to accelerate this cycle of cuts.” This cautious approach reflects the tension between a desire to stimulate the economy and lingering fears about inflationary risks. In the round of statements by the members of the Governing Council this Friday, after lifting the media silence prior to the meeting, the Latvian Martins Kazaks has slipped that the option of the ‘jumbo’ cut is a ‘lifesaver’ from which the seal cannot be removed if the outlook does not suddenly worsen.
The ECB narrative, according to analysts, reveals an institution caught between the lessons of the past and the uncertainties of the future. Although the abandonment of its restrictive stance is a significant change, the central bank remains reluctant to fully embrace a bolder approach. “The ECB is moving towards neutrality, but at a speed dictated by the data, meeting after meeting,” they conclude in BofA.
This behavior, similar to that driver who keeps looking at the mirror rear-view mirror, raises questions about the ECB’s ability to respond with the necessary agility to a rapidly evolving economic environment. As markets await more decisive signals, the transition to looser monetary policy could be crucial to restoring confidence in the European bloc. However, the challenge remains to balance these expectations with the reality of still uncertain economic forecasts.
Lowering and lowering terminal type
More experts, apart from those at BofA, Pimco or Fidelity, have begun to lower the ECB’s terminal rate. This trend had already started a long time ago. According to a report recently published by Deutsche Bankright now the terminal rate will be between 1% and 1.75%, a much lower range than the previous forecast of 2.25%. The German bank’s analysts thus joined other strategists who have been telegraphing a terminal rate below 2% for weeks, as did Mathieu Savary, chief strategist of BCA Researchin statements to elEconomista.eswho opened the door even to a meager 1% floor in pursuit of growth.
Beyond the messages that Christine Lagarde launched yesterday, the decision to reduce the terminal interest rate also responds, in part, to the impact of possible tariffs imposed by the new Trump administration in the USthe slowdown of the economy or the possible ‘massive’ arrival of low-priced Chinese goods to Europe as a product of the first reason.
“The prospect of higher US tariffs threatens a new terms of trade shock,” warn Deutsche Bank economists, who also highlight that these tariffs could trigger an increase in economic uncertainty, similar to the situation experienced in 2018-2019. during Trump’s first term. The euro zone is a net exporter and a good part of its citizens’ income comes from a high current account surplus. Tariffs threaten to reduce this surplus and hamper the growth of the European continent, at the same time that part of the goods that China sells today to the US may be redirected to Europe at knockdown prices.
Although the European economy has shown signs of resilience, with positive GDP growth in the first three quarters of 2024, underlying macroeconomic data is weak, and projected growth for the coming years has been revised downwards. The central bank staff contemplates GDP growth in the region of 0.7%, the aforementioned 1.1% in 2025, 1.4% in 2026 and 1.3% in 2027. This means cutting one tenth September’s forecast for 2024 (was 0.8%) and next year’s forecast by two tenths (was 1.3%). The forecast for 2026 has also fallen by one tenth. “The staff is waiting now a slower economic recovery than in the September projections. Although growth picked up in the third quarter of this year, survey indicators suggest that it has slowed in the current quarter,” says the Governing Council. This will require a lower terminal rate to revive the economy.
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