Lowering rates could provide a much-needed boost to borrowing, consumption and exports from a weaker euro, but the costs of geopolitical risks could limit the benefits.
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The European Central Bank (ECB) continues on the path of monetary easing in October 2024, after July and September 2024. The ECB is preparing to reduce its main key rate, called the deposit rate, on Thursday by 25 basis points from at 3.25%.
This is the third consecutive reduction in borrowing costs, as the euro zone faces slowing economic dynamics and easing inflationary pressures.
Although this decision is taken for granted by market participants, attention will focus on ECB President Christine Lagarde’s guidance on the way forward.
Given the moderation in inflation and weak economic growth, economists and analysts predict that the central bank will maintain its easing policy until 2025.
How far could the ECB cut interest rates after December?
This week’s drop will not be the last.
Economists and analysts are almost unanimous in predicting a 25 basis point cut, and projections point to a new round of gradual easing through 2025.
US bank Bank of America expects the ECB to maintain its current pace, cutting rates at each meeting until the deposit rate reaches 1.5% in September 2025.
“With the economy growing at or below trend for most of 2025, it will be difficult for the ECB to halt rate cuts until the deposit rate falls slightly below its estimate of the neutral level of 2%”Bank of America analysts said. They add: “At this point, 1.5% easily becomes an upper limit.”
Danske Bank, one of Denmark’s leading banks, shares this view and predicts that the ECB will make a series of cuts over the next two years, ultimately reaching a terminal deposit rate of 1.5%.
Goldman Sachs paints a similar picture, with its base case scenario calling for sequential cuts of 25 basis points until the deposit rate hits 1.75% in July 2025. The investment bank expects the Governing Council of the ECB abandons the references of the declaration on the maintenance of “policy rates sufficiently restrictive for as long as necessary”, and Christine Lagarde hinting at a further rate cut in January.
How could inflation change?
Thursday’s meeting will also be marked by new economic projections from the ECB, which could provide guidance on the trajectory of monetary policy.
ABN Amro, a Dutch bank, expects only minor changes in the ECB’s growth forecasts, but anticipates a larger revision to inflation projections for 2025. “We believe headline inflation for 2025 could see a more significant downward revision, with our forecast of 2% compared to the September projection of 2.2%”said Arjen van Dijkhuizen, senior economist at ABN Amro.
The risk of inflation below the ECB’s target could justify prolonged rate cuts. Bank of America expects Christine Lagarde to stress that the risk of inflation overshooting has diminished, leaving room for policy rates to fall below neutrality if economic conditions worsen.
Is the euro facing downside risks?
The ECB’s “Dovish” course change – a monetary policy that targets economic growth – could put downward pressure on the euro, a scenario that some analysts see as likely in the coming months. Bank of America sees “modest downside risks for the euro following the meeting and around the relative attitude of the ECB in the months to come”.
Chris Turner, analyst at ING Group, remains bearish on the euro and thinks the single currency “is now ready to resume its downward trend if macro and geopolitical factors allow”.
ADVERTISEMENTHe added: “This month, EUR/USD remains offered despite a strong seasonal uptrend. Generally, January and February are bearish months for EUR/USD.”
How can lower interest rates affect the real economy of the Eurozone?
Lowering interest rates aims to stimulate economic activity by making borrowing cheaper for households and businesses. In the euro zone, where small and medium-sized businesses rely heavily on bank loans, cheaper credit could give a much-needed boost to investment.
For sectors such as real estate, the benefits could be very significant. Mortgage rates, which have soared in recent years, could fall as central bank cuts ripple through financial markets. This could help revive demand for housing, after years of sharp slowdown in sales.
Lower borrowing costs could also encourage households to spend more on major purchases such as cars, home improvements or durable goods, boosting domestic consumption.
ADVERTISEMENTA weaker euro, which could result from the ECB’s “Dovish” stance, further amplifies these effects. As the currency depreciates, euro zone exports become more competitive in global markets, which can represent a boon for export-heavy industries, such as car manufacturing, machinery and chemicals.
However, currency depreciation is a double-edged sword. While exports may be thriving, a weaker euro increases the cost of imported goods, including energy and raw materials. This could partly offset the benefits of lower borrowing costs, particularly for businesses that rely on imported inputs.
However, geopolitical uncertainties, including ongoing conflicts in Ukraine and the Middle East, as well as looming trade tensions with the United States – particularly the threat of new tariffs – represent a clear challenge for European businesses.
Businesses may be reluctant to invest or expand despite favorable financial conditions, highlighting the limits of monetary policy in an unpredictable global environment.
ADVERTISEMENTUltimately, ECB rate cuts are a crucial tool to support economic activity, but their effectiveness will depend on how businesses, consumers and global markets respond in the months to come.
