(Bloomberg) — The European Central Bank is pushing back against investors who reckon firmer inflation, a surprisingly sturdy US jobs market and Donald Trump’s economic disruption will narrow the scope to lower interest rates.
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While markets have pared bets on the number of cuts they expect this year from the ECB — and the Federal Reserve — officials in Frankfurt are unperturbed. Governing Council members like Francois Villeroy de Galhau and Yannis Stournaras have reiterated long-held beliefs that the deposit rate will fall to about 2% by mid-2025, from 3% today.
For now, they’re looking through heightened uncertainty stemming mainly from US trade policy but also from a more hawkish Fed and political upheaval in Germany and France. While the ECB could yet change course, it’s unlikely to do so at least until it digests March’s quarterly projections, which will capture the effect of Trump’s initial actions.
“Markets can often react too quickly,” and “central banks on both sides of the Atlantic will try to not overreact to single data points,” said Gilles Moec, chief economist at AXA Investment Managers. “From Trump’s inauguration onward, we should get a better picture of his ‘transformation rate’ from electoral proposals to policy implementation.”
President Christine Lagarde pledged in December to continue following a “data-dependent and meeting-by-meeting approach” in setting rates. In Europe, at least, the data have since strayed little from forecasts.
While some traders may have zeroed in on the recent uptick in inflation, a year-end pickup was flagged by the ECB, whose analysts see the overall retreat in price gains progressing as anticipated and expect less upward pressure from wages in 2025. The economy, meanwhile, is still struggling — even before Trump unleashes his tariffs.
Developments in the US may, in fact, explain why markets now only price three quarter-point rate cuts through June — one less than at the start of 2025. For one, there’s a labor market that continues to defy predictions it will soften. There’s also the prospect of tax cuts and mass deportations that could keep inflation hot.
Already in December, Fed policymakers reduced the number of rate cuts they envisage in 2025 to two from four. Traders now see just one, and economists including those at BNP Paribas and Nikko Asset Management even wonder if a hike could come next.
This has revived a debate from 2024 about how far the ECB can diverge from the Fed. Like then, ECB officials such as Croatia’s Boris Vujcic have been quick to quash talk that they’re overly influenced by what their US peers do.
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“A cautious Fed won’t deter the ECB from further rate cuts,” said Christian Keller, head of economics research at Barclays. “The ECB will want to keep an eye on the exchange rate and avoid large, abrupt depreciations, but it won’t refrain from lowering rates in principle.”
The single currency has lost about 3% in trade-weighted terms since Sept. 30 and more than 8% against the dollar, bringing it dangerously close to parity. That level was last breached in 2022 after Russia’s invasion of Ukraine sent energy prices soaring.
While a weaker euro brings fresh inflation risks, they’re probably limited, said Ludovic Subran, chief economist at Allianz. “The ECB is likely going to be more concerned about growth issues in light of a looming trade war,” he said.
Finland’s Olli Rehn told Bloomberg TV on Monday that “against the backdrop of disinflation being on track and the growth outlook having weakened it makes sense to continue rate cuts,” with incoming data to determine the scale and speed.
Investors, though, will probably still need more convincing that the ECB will deliver the four reductions many of its policymakers have telegraphed — despite warnings that price gains could slide materially below target if borrowing costs stay too high for too long.
“Markets expect to hear comments like these from Rehn and other moderates,” said Pooja Kumra, senior UK and European rates strategist at Toronto Dominion Bank. “We’ll need to see a similar stance from Lagarde and more hawkish members like Isabel Schnabel for market pricing to shift.”
Top hawk Robert Holzmann was unwilling to do that on Tuesday. While known for taking extreme positions, he said the ECB’s next policy decision, on Jan. 30, is unclear.
–With assistance from Alexander Weber and Marton Eder.
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