European Central Bank Cuts Rates by 25 bps as Expected, Despite Higher Inflation Projections for 2024 and 2025

European Central Bank's Rate Cut and Economic Outlook

The European Central Bank (ECB) has reduced its benchmark interest rates by 25 basis points, aligning with market expectations. This adjustment lowers the primary refinancing rate to 4.25% and the deposit rate to 3.75%. It marks the ECB's first rate cut since 2019, prompted by revised inflation forecasts for 2024 and 2025.

ECB Rate 

 Source: Finlogix Economic Calendar Justification for the Rate Cut

In a press release, the ECB cited a reassessment of inflation prospects, underlying inflation dynamics, and the effectiveness of monetary policy transmission as reasons for the rate cut. After maintaining steady rates for nine months, the bank deemed it necessary to relax its economic policies. This decision follows a significant decline in inflation by over 2.5 percentage points since the ECB's Governing Council meeting in September 2023.

"Given the progressive decline in inflation and an improved overall inflation outlook, monetary policy should now be less restrictive," the ECB stated. "Our policy has kept financing conditions tight, supporting the rebalancing of demand and containing inflation expectations—thus playing a crucial role in reducing inflation."

Economic Background and Projections

The ECB highlighted that while external price pressures have recently eased, substantial domestic price pressures persist, driven by robust wage growth. These factors suggest that inflation will remain above target well into the next year. According to the Eurosystem's latest staff projections, headline inflation is expected to average 2.5% in 2024, decreasing to 2.2% in 2025, and 1.9% in 2026. Excluding energy and food, inflation is projected at 2.8% in 2024, 2.2% in 2025, and 2% in 2026.

Economic growth is also anticipated to improve, with GDP growth forecasted at 0.9% in 2024, 1.4% in 2025, and 1.6% in 2026.

Future Rate Cuts and ECB's Stance

The ECB indicated that it would adopt a cautious approach to future rate cuts. The bank reaffirmed its commitment to achieving its medium-term inflation target of 2% without unnecessary delays. "The Governing Council will maintain policy rates at sufficiently restrictive levels for as long as necessary to meet this objective," the statement read.

Future interest rate decisions will be made on a meeting-by-meeting basis, heavily reliant on incoming economic and financial data, as well as changes in underlying inflation transmission dynamics.

Revised Economic Projections

2025 Inflation: The ECB revised its forecast to 2.2% from the previous 2%.2026 Inflation: The forecast remains at 1.9%.By adjusting its inflation target for 2025 while simultaneously cutting rates, the ECB aims to balance the support for economic growth with the containment of inflationary pressures.

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