The European Central Bank took a cautious approach and cut its key interest rate by another 0.25 percentage points to 3.00% on Thursday, while revising down its growth forecast and inflation outlook for the years 2024 - 2027. The ECB’s 0.25 percentage point cut to its deposit rate had been widely expected. In its statement, it dropped the reference to restrictive monetary policy and left the door wide open for further cuts in 2025.
The governing council reiterated that it will follow a data-dependent and meeting-by-meeting approach and not commit to a particular rate path, but remains determined to ensure inflation stabilizes at its 2% medium-term target.
ECB Signals an Easing Bias
“The ECB continued to describe current financing conditions as tight but dropped the reference to needing to keep policy sufficiently restrictive for as long as necessary,” Mark Wall, chief European economist at Deutsche Bank, said in a statement after the rate cut.
“This combination signals an easing bias. For a market that has been pricing the chances of a sub-neutral terminal rate in 2025 today’s ECB decision will feel like an endorsement,” he added.
Michael Field, Morningstar’s European markets strategist, said that risks remain in Europe, but an “overheating economy is not high on the list”.
“Economists expect a further 100 basis points of rate cuts in 2025, which would bring deposit rates close to 2%. A structurally lower level of interest rates would be a boon for European equities, particularly those exposed to consumer spending.”
Changes to the ECB’s Key Interest Rates
The ECB began its rate-cutting cycle in June, paused in July, and resumed its rate adjustments in September and October. As of Dec. 18, the three ECB key interest rates will stand at:
• Deposit facility rate: 3.00%
• Main refinancing rate: 3.15%
• Marginal lending facility: 3.40%
On Thursday morning, the Swiss National Bank surprised markets with a steeper-than-expected 0.5 percentage point rate cut amid low inflation and a strong Swiss Franc. The US Federal Reserve will announce its rate decision next Wednesday and the Bank of England on Thursday.
ECB Lowers Inflation and Growth Outlook
The bank’s staff see headline inflation averaging:
- 2.4% in 2024 (down from 2.5% in the bank’s September forecast)
- 2.1% in 2025 (down from 2.3%)
- 1.9% in 2026 (down from 2.0%)
- 2.1% in 2027, when the expanded EU Emissions Trading System becomes operational. This is the first time the bank’s economist forecast for 2027.
For inflation excluding energy and food, staff project an average of 2.9% in 2024, 2.3% in 2025 and 1.9% in both 2026 and 2027.
Forecasts for Eurozone GDP
ECB staff see the eurozone economy growing by:
- 0.7% in 2024 (down from 0.8% in September)
- 1.1% in 2025 (down from 1.3%)
- 1.4% in 2026 (down from 1.5%)
- 1.3% in 2027 (first estimate)
“Eurozone inflation stands at 2.3%, slightly above the ECB’s 2% targeted rate. The feeling however is that, for the most part, inflation is under control. We’ve come a long way since the almost double-digit levels of inflation, and while wages are still catching up, the recent bump in services inflation is likely temporary,” Morningstar’s Field said.
Market Reaction to the ECB’s Rate Cut
European stocks turned slightly into positive territory after the expected policy move, while the euro edged lower against the dollar.
“Every single economist surveyed recently by Reuters expected at least a 25 basis point rate cut in the December meeting, and that’s exactly what they got. While well flagged, such a move was still well received by European equity markets, which we believe are still trading at a discount to their fair value,” Field added.
Eurozone Challenges Go Beyond Rates
Political uncertainty in France and Germany continues to weigh on the eurozone. In France, heightened political risks following a no-confidence vote have pushed the OAT-Bund spread, a measure of country-specific bond risk, higher, near 0.85 percentage points at its peak. Spreads haven fallen to around 0.77 as of Dec. 11. The German Bund is the benchmark security for the eurozone.
In Germany, Chancellor Olaf Scholz has initiated a parliamentary confidence vote scheduled for Dec. 16, which will lead to early elections on Feb. 23 next year. This political uncertainty has contributed to volatility in German bund yields, as markets assess the fiscal implications of the ongoing instability.
The ECB and Fed Take Different Paths
While the ECB embarks on a robust easing cycle, the US Federal Reserve is expected to maintain a more cautious approach. This divergence could weaken the euro against the dollar, potentially benefiting eurozone exporters.
Even after a strong November jobs report and sticky inflation data, investors expect the Fed to cut interest rates this month, says Morningstar’s US economist Preston Caldwell. “They see a 96.4% chance of a 0.25 percentage point cut next week, according to the CME FedWatch Tool. That would bring the target federal funds rate down to a range of 4.25%-4.50%, a full percentage point lower than its peak earlier this year.”
Caldwell says the outlook is less certain: “Markets still seem to be pricing in an overwhelming probability of a cut, but we see the outcome as more of a coin flip.”
How Will Rate Cuts Affect Markets?
Equity markets tend to rise on anticipated rate cuts. In bond markets, falling interest rates mean lower yields, which pushes bond prices higher. Lower rates also make existing bonds, and particularly those already issued during a period of high rates, more attractive for yields.
Meanwhile cash savings rates on bank accounts will likely decrease, to the detriment of savers. The rates that savers receive depend mostly on the deposit facility, which defines the interest banks receive for depositing money with the ECB overnight. Borrowers, by contrast, benefit from lower rates as consumer debt and mortgages become cheaper.
When Are the ECB Meetings in 2025?
- 30/01/2025
- 06/03/2025
- 17/04/2025
- 05/06/2025
- 24/07/2025
- 11/09/2025
- 30/10/2025
- 18/12/2025
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
