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ECB continues its easing cycle as expected

Decision in line with expectations

On 30 January, the ECB cut its deposit rate, by 25 basis points to 2.75%. Consequently, the refinancing rate and the marginal lending rate fell mechanically to 2.90% and 3.15% respectively. That decision is in line with the scenario of both KBC Economics and of financial markets. Consequently, the bond market hardly reacted. The German 10-year government rate remained near 2.50%. 

ECB sees Inflation on track 

According to the ECB, disinflationary process is on track in line with the ECB economists' scenario. Moreover, according to the ECB, most indicators of underlying inflation suggest that inflation will return to the 2% inflation target in a sustainable manner during 2025.

Euro area inflation is likely to remain around current levels in the first few months, according to ECB president Lagarde, due in part to statistical base effects caused by the comparison with energy prices from a year earlier, and the still relatively high services price inflation. Thereafter, however, inflation is expected to reach the 2% inflation target on a sustained basis during 2025. To this end, President Lagarde mainly referred to the expected moderation of wage cost growth in the euro area. Together with a partial absorption of wage pressures in firms' price margins, this should lead to wage developments consistent with the 2% inflation target over the medium term.

The ECB considers the transmission on the European economy and credit growth from its monetary policy easing since 2024 to be intact, despite the recent rise in long-term bond yields. These were mainly triggered by economic developments in the US, and are in part a negative exogenous financial shock to the European economy.

Data dependence, meeting-to-meeting and no commitment for future policy

ECB president Lagarde confirmed that the ECB remains data-dependent in terms of its the further interest rate path, reviewing and determining policy from meeting to meeting, and that the ECB does not commit to any particular future interest rate path. However, she did make it clear that the direction of future policy interest rates is downward. Indeed, she described the current interest rate level as still restrictive. She also did not comment on the level of the bottom of the deposit rate in this interest rate cycle. She referred to a new study by ECB economists to be released on 7 February, which will be one of the sources of information on which ECB policymakers will rely.

Wait-and-see approach to the impact of possible trade frictions

The baseline scenario for the ECB remains a continuation of the cyclical recovery in the euro area through 2025. The stagnation of growth in the fourth quarter of 2024 does not detract from this, according to President Lagarde. She did clarify that the growth risks for the ECB are tilted to the downside, and that the baseline scenario assumes that trade frictions do not escalate during 2025.

The uncertainty surrounding the possible impact of US import tariffs is so high, according to the ECB, that it cannot include assumptions on this in its baseline scenario at this stage. This is in line with the stated data-dependence of its future policy. President Lagarde also referred to the fact that new ECB economists' forecasts will be available in March, together with two additional inflation figures and probably additional information on the new US economic and trade policy. Barring any major surprises, we therefore expect (as does the market) that on the basis of this additional information, the ECB will cut its policy rate again by 25 basis points in March. 

KBC Economics scenario and market expectations

KBC Economics expects the ECB to cut its policy rate by 25 basis points at each of the next three policy meetings, reaching the 2% floor for its deposit rate in this cycle by mid-2025. Until recently, the market expected a lower cyclical bottom rate, but the market expectations have shifted up to the KBC Economics scenario mainly driven by the US policy plans becoming more concrete. The only remaining difference is that the market does expect the ECB to reach that bottom of the deposit rate slightly later, namely in September relative to the KBC Economics expectation that this will already be the case in June.

A key discussion remains where the neutral policy rate for the ECB lies. As mentioned above, the publication of an ECB study on 7 February may shed a bit of more light on the range the ECB is thinking of in this regard. In this context, President Lagarde reiterated that ECB policy is data-dependent (probably mainly a reference to future trade policy) and that the ECB therefore has no estimate at the moment of the level of the neutral interest rate, let alone on whether or not it should drop its policy rate below that at some point to stimulate the European economy.

According to KBC Economics' current assessment, the expected 2% bottom for the ECB’s deposit rate is mildly stimulative, motivated by an ECB precautionary motive. After all, under the assumption of 2% inflation, this corresponds to a real policy rate of 0%. As it will gradually become clearer that, in line with both the ECB's and KBC Economics' scenario, the existing risks do not derail the euro area’s  recovery in 2025, it is plausible, in our view, that the ECB could withdraw a part of its monetary stimulus again thereafter.

ECB sees door wide open for euro introduction in Bulgaria

President Lagarde also said that euro adoption in Bulgaria is a step closer following the Bulgarian authorities' request for a new convergence report on the matter. ECB President Lagarde confirmed that, regarding the economic convergence criteria, and in particular the inflation convergence, the door for a euro adoption in Bulgaria is now wide open for the ECB.

Disclaimer:

Any opinion expressed in this publication represents the personal opinion by the author(s). Neither the degree to which the hypotheses, risks and forecasts contained in this report reflect market expectations, nor their effective chances of realisation can be guaranteed. Any forecasts are indicative. The information contained in this publication is general in nature and for information purposes only. It may not be considered as investment advice. Sustainability is part of the overall business strategy of KBC Group NV (see https://www.kbc.com/en/corporate-sustainability.html). We take this strategy into account when choosing topics for our publications, but a thorough analysis of economic and financial developments requires discussing a wider variety of topics. This publication cannot be considered as ‘investment research’ as described in the law and regulations concerning the markets for financial instruments. Any transfer, distribution or reproduction in any form or means of information is prohibited without the express prior written consent of KBC Group NV. KBC cannot be held responsible for the accuracy or completeness of this information.

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