At its first monetary policy meeting of 2025 on Jan. 30, the European Central Bank is widely expected to cut its key interest rate by another 0.25 percentage points to 2.75%, continuing its easing cycle amid an uncertain economic outlook and sticky services inflation. The market anticipates further cuts, with another 1 percentage point of reductions priced in for the year.
ECB Set for Rate Cuts, but Inflation Remains a Factor
“The ECB is expected to lead the way once again in 2025 with rate cuts, with the first coming as early as next week,” said Michael Field, European market strategist at Morningstar.
“The market is currently pricing in 100 basis points of rate cuts, compared with only around half this level at a push for both the US Federal Reserve and the Bank of England. This of course hinges on inflation remaining under control in Europe. At 2.4% in December, it’s the lowest of the three regions, but should this tick up any higher, then all bets are essentially off.”
“So far, the ECB’s moderately paced and methodical approach to cutting interest rates has been spot on. Comments over the holiday period from the bank suggest they believe inflation will fall again to the targeted level this year, paving the way for further rate cuts.”
The ECB began its rate-cutting cycle in June 2024, paused in July, and resumed its rate changes in September, October, and December.
Key ECB Interest Rates
- Deposit facility rate: 3.00%
- Main refinancing rate: 3.15%
- Marginal lending facility: 3.40%
Where Will Eurozone Interest Rates End Up?
“We expect the ECB to cut by 25 basis points at each of the four governing council meetings in the first half of the year, lowering the policy rate to 2.00% by mid-year,” Mark Wall, chief economist at Deutsche Bank, wrote in the bank’s ECB outlook on Jan. 23.
“In the second half, we expect the pace of cuts to slow, with one 25-basis-point cut per quarter, bringing the terminal rate to 1.50% by year-end.”
Wall said that these projections hinge on below-trend growth and inflation risks remaining under control. The ECB governing council views achieving a neutral interest rate of around 2% as an important milestone, with further cuts depending on economic conditions and data dependency. ECB President Christine Lagarde has stressed that the bank will remain data dependent and look at the most appropriate rate per policy meeting.
ABN Amro economists wrote in an ECB preview that the neutral level is subject to debate, but around 2% seems to be a level that most ECB policymakers support. Several members of the ECB governing council have said that we should reach this interest rate level by summer.
“We believe that incoming data and economic developments would have to deviate significantly from current ECB expectations for the central bank to change its mind. The bar for deviating from this gradual rate cut path seems quite high at the moment,” the economists wrote.
Trump Tariffs: A Key Challenge for the Eurozone
Risks remain in Europe, and many of these are to the downside, with US trade restrictions in 2025 now close to top of the list.
“Market participants have already priced in a deeply negative outlook for Europe across credit and equity markets,” Orla Garvey, senior fixed income portfolio manager at Federated Hermes, told Morningstar on Jan. 23. The 1-percentage-point rate cut that the market anticipates for 2025 is reasonable, she added.
“For a more drastic ECB cut we would need to see very negative surprises to the downside.”
She expects markets to be more volatile going forward with risks on both sides emanating from US President Donald Trump. “Europe will depend on what happens to tariffs, not so much on the ECB,” she stressed.
This sentiment is echoed by ABN Amro, who stress that what happens after more neutral interest rate levels are reached depends largely on the new U.S. administration’s import tariff policy.
The dispersion of growth across the eurozone is also challenging for the ECB, with Germany lagging while countries like Spain and Portugal exhibit reasonable growth. The German election on Feb. 23 will be closely watched for any sign that a new government will be willing to increase fiscal spending.
Why Are Bond Yields Rising as Rates Fall?
Despite falling ECB policy rates, bond yields in the eurozone have risen. This situation undermines the intended easing effect of rate cuts on credit conditions because higher bond yields mean higher borrowing costs for governments and enterprises, potentially slowing economic growth, DWS macro analyst Ulrike Kastens said.
German bund yields rose sharply in late 2024, with 10-year yields climbing from 2.02% in December to 2.65% in January 2025. This reflects rising US Treasury yields amid concerns about US fiscal policy. In addition, inflation in the eurozone and especially Germany has surprised to the upside.
Eurozone national central banks also halted their principal reinvestments as part of the ECB’s pandemic emergency purchase program at the end of 2024, Shannon Kirwin, manager research analyst at Morningstar, said.
“The expiration of PEPP cuts demand, while at the same time many investors expect government bond issuance by Germany and France to increase going forward as the governments may increase spending, which ramps up supply.”
Inflation in the Eurozone on a Bumpy Path
“Inflation has remained on a volatile trajectory, complicating the ECB’s decision-making. Projections show increasing confidence that inflation is nearing the ECB’s target, but recent upward surprises, particularly in Germany, suggest this confidence could be tested,” said DWS’ Kastens.
Wall cautioned that higher energy prices or sticky domestic inflation could lead to hawkish tweaks in the ECB’s communication. But he said that a shock would be required for the ECB to deviate from its gradual approach, such as cutting rates by 50 basis points instead of the anticipated 25.
“The main risk in January is tweaks to the ECB’s description of recent data leaning more hawkish, but the expectation is a steady march toward neutral rates,” Deutsche Bank noted.
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.
