Will the European Central Bank cut interest rates at its last meeting of the year to ease pressure on the economy?

Will the European Central Bank cut interest rates at its last meeting of the year to ease pressure on the economy? The expected scenario

December 11, 2024

The European Central Bank is set to make its last interest rate decision of the year on Thursday, when it is likely to cut rates by 25 basis points to 3%, marking the third consecutive cut in borrowing costs, after previous cuts from 4% to 3.25% in 2024.

While a rate cut scenario is widely expected, the ECB’s guidance on future policy will be key for markets to watch, especially as the eurozone faces economic challenges, most notably slow growth. Inflation and economic growth expectations

The European Central Bank's quarterly economic outlook report due this meeting is expected to be an important part of the meeting, as while inflation in the euro area has slowed significantly so far, there is still a great deal of uncertainty about the path of interest rates and a further slowdown in inflation rates.

Economists expect the European Central Bank to cut its inflation forecast for 2025, potentially revising its forecast from 2.2% in September to around 2%. This revision reflects a reduced risk of inflation accelerating or continuing to record high rates, which could prompt the ECB to continue gradually reducing interest rates until they reach the neutral rate.

While inflation remains a priority for the ECB, the weak outlook for economic growth in the eurozone is increasingly on the table among policymakers. The region’s economy grew by just 0.4% in the third quarter of 2024, its fastest pace in two years, but still below the ECB’s growth forecast.

With GDP growth still weak and Germany, the region’s largest economy, in recession, further interest rate cuts by the European Central Bank are likely to be warranted to stimulate demand and support investment. Expectations of continued monetary easing in 2025

Bank of America has revised its forecasts, now expecting the European Central Bank to cut interest rates at every meeting until September 2025, with the rate reaching 1.5% by the end of next year. Bank of America analysts believe the eurozone economy will continue to grow below trend, making it difficult for the ECB to stop rate cuts until the rate gradually falls below the neutral level of 2%. They expect the neutral rate to settle at around 1.5%.

Danske Bank shares a similar outlook, predicting a series of 25 basis point cuts over the next two years, eventually pushing the ECB’s interest rate to 1.5%. This would help stimulate demand by making borrowing cheaper for households and businesses, especially in credit-heavy sectors such as real estate and small businesses.

Goldman Sachs also expects steady rate cuts, seeing the rate at 1.75% by mid-2025, slightly higher than other forecasts. At the December meeting press conference, Goldman Sachs expects ECB President Christine Lagarde to signal further cuts, starting in January 2025, as economic conditions warrant continued easing. The impact of the ECB’s decision on the euro and financial markets

The continued dovish stance of the European Central Bank on interest rates over the coming period is expected to put downward pressure on the euro, as analysts expect the euro to resume its downward trend, especially since the ECB's policies differ in direction from those of other major central banks, most notably the US Federal Reserve.

On the other hand, Bank of America expects modest downside risks to the euro as a result of the ECB’s more accommodative stance, noting that a weaker euro would make European exports more globally competitive, benefiting the continent’s key manufacturing sector, especially auto, machinery and chemicals.

However, a potential weaker euro still poses risks to inflation and growth, as it could also raise the cost of imports, especially energy and raw material prices, which could offset the benefits of higher exports for companies that rely on imported inputs.

Chris Turner of ING Financial Group also expects the euro to continue its downward trend, especially if macroeconomic factors and geopolitical tensions worsen. The analyst points out that January and February are typically weaker months for the euro, and that the ECB’s more dovish stance on monetary policy could exacerbate this trend. Expected scenarios for the ECB decision

Scenario 1: The bank cuts interest rates by 25 basis points, and the bank’s governor Christine Lagarde hints at further successive cuts in monetary rates to ease economic pressures, especially as inflation approaches the 2% inflation target; this scenario will likely have a negative impact on the euro.

The second scenario, which is the least likely, is that the bank will provide a larger reduction of 50 basis points to provide some support to economic activity, while hinting at the possibility of keeping interest rates stable at the beginning of next year. This scenario is also expected to have a negative impact, but less severe, on the euro.