ECB cuts interest rates as inflation slows, but economic recovery remains fragile

The European Central Bank (ECB) has announced a 25 basis point cut to its three key interest rates, marking a significant step in its ongoing efforts to adapt monetary policy to the evolving economic landscape. The decision, which includes lowering the deposit facility rate to three per cent, reflects the ECB’s updated inflation outlook and the need to ease financing conditions across the euro area.

This is the fourth interest rate cut in 2024 by the ECB, followed by previous cuts in October, June and September. The development illustrates a global trend to ease monetary policy, with the US Federal Reserve implementing a 50 basis point cut in September 2024, followed by a 25 basis point reduction in November, setting the rate between 4.5 and 4.75 per cent. Meanwhile, The Bank of England decreased its main interest rate by 25 basis points in August 2024, and again in November 2024 by the same amount, reducing the rate to 5.475 per cent.

According to the ECB, headline inflation is projected to average 2.4 per cent in 2024, before declining to 2.1 per cent in 2025 and stabilising at the medium-term target of two per cent by 2026. This trajectory aligns with the central bank’s assessment that the disinflation process is progressing well. However, underlying inflation — which excludes volatile energy and food prices — remains elevated, averaging 2.9 per cent in 2024 and 2.3 per cent in 2025, before converging with the two per cent target in subsequent years.

ECB President Christine Lagarde highlighted that while financing conditions are gradually easing, they remain tight due to the lingering effects of past interest rate hikes. “We are committed to ensuring inflation stabilises sustainably at our medium-term target,” Lagarde stated, adding that the ECB will maintain a data-driven approach to future decisions.

Economic growth, however, paints a less optimistic picture. The ECB’s staff projections show the euro area economy growing by just 0.7 per cent in 2024, followed by modest recoveries of 1.1 per cent in 2025 and 1.4 per cent in 2026. Slower-than-expected recovery stems from weak domestic demand and delayed adjustments in wages and prices following the inflation surge.

For businesses, the rate cut signals a potential easing of credit conditions, albeit within a restrictive monetary framework. Companies planning investments may find borrowing slightly less costly, though cautious consumer sentiment and global economic uncertainties will potentially temper immediate gains.

The ECB also announced it will discontinue reinvestments under the Pandemic Emergency Purchase Programme (PEPP) at the end of 2024, concluding another phase of balance sheet normalisation. These decisions underscore the central bank’s dual focus on fostering economic recovery while maintaining price stability across the eurozone.