By Balazs Koranyi and Francesco Canepa
FRANKFURT (Reuters) – The European Central Bank is set to cut interest rates again on Thursday in what is likely to be its last easy decision for a while as trade wars and rearmament drive the continent’s biggest economic policy upheaval in decades.
With the outlook shifting at a faster pace than economic models can match and its policymakers increasingly split about the need for more support, the focus will be on what signals the ECB sends about future moves.
After cutting borrowing costs rapidly over the past nine months as inflation retreated and economic growth faltered, the euro zone’s central bank has telegraphed another 25 basis point reduction in the deposit rate on Thursday, taking it to 2.5%.
The outlook beyond that is more complicated.
Rates are slowly approaching a level that no longer restricts economic growth, which might normally herald an end to the easing cycle.
But these aren’t normal times.
A trade war with the United States is looming and growth is already taking a hit as firms hold back investment, fearing that extended conflict will hurt demand.
Meanwhile Germany and the European Commission have both announced transformational changes in fiscal rules to boost defence and infrastructure spending, partly to replace U.S. support – a tectonic shift that could impact growth for years.
“This is the last ‘easy’ cut as disagreement grows,” Bank of America analysts said in a note. “We don’t think the guidance will change … but we would expect growing disagreement among Governing Council members.”
RESTRICTIVE?
The ECB will struggle to keep up with the rapid change in the outlook.
Its new economic projections, based on data collected weeks ago, are likely to show weaker growth and a slightly higher inflation trajectory.
But policymakers will be more pragmatic, recognising that the world has moved on since the cut-off date for the forecasts and that they now face exceptional uncertainty.
“There will be pressure to slow down ECB easing, owing to growth re-rating, although cooling wages and employment, lags in fiscal policy effects, and escalating U.S. tariff threats against the EU keep a sub-2% deposit rate as the base case,” TS Lombard’s Davide Oneglia said.
The key to look for on Thursday is whether the ECB maintains its language that policy “remains restrictive” or drops it, which would suggest policymakers feel they are close to achieving their aim.
But even removing that phrase would not necessarily mean a pause – instead, it could signal greater uncertainty and a noisy debate in the weeks leading up to the next policy meeting.
The ECB’s projections themselves embed market bets on rate cuts, so if inflation is still seen at 2% by the end of the year, then two more rate cuts will remain the ECB’s base case.
Also suggesting that easing has room to run, the ECB’s models show the deposit rate stops restricting growth in the 1.75% to 2.25% range.
Another item to watch is whether ECB President Christine Lagarde maintains her line that the direction of policy is clear and only the timing and magnitude of easing up for debate.
For now, investors think the ECB will keep going.
Markets are pricing two more rate cuts this year after Thursday’s move, slightly less than before Tuesday’s German budget announcement but still within the range of expectations seen in the past few weeks.
The ECB will announce its policy decision at 1315 GMT, followed by Lagarde’s 1345 GMT press conference.
(Editing by Catherine Evans)
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