What's next for the ECB?

ECB: cuts rates, but Lagarde points to end of cutting cycle

The ECB cut rates today, however, the outlook is unclear. The ECB did not provide much in the way of forward guidance, however, ECB President Christine Lagarde said that the Bank is getting near to the end of the rate cutting cycle with today’s cut.

This was a hawkish surprise that the market was not expecting. After initially falling sharply, European bond yields have reversed course and are now higher on the day. European stock indices are weaker across the board and the euro is surging.

Although the ECB is still expected to cut rates one more time, the market is pricing in a 45% chance of a cut in September, which is down from a 55% chance of a cut earlier this week. It is no surprise that Lagarde has prepped the market for the end of this loosening cycle. Rates have now been cut 8 times, with the potential for a 9^th cut later this year. Eurozone interest rates are also around neutral.  While we do not think that rates will rise any time soon,  rates could remain around 1.75-2% for the long term.

Rate cuts have done their job

Anyone who expected the ECB to rates to the bone have been left disappointed. Some may argue that this is contradictory considering the ECB staff forecasts cut the currency bloc’s inflation expectations for the next two years. However, we do not think so. Instead, it suggests that ECB rate cuts have done their job and may not be needed going forward.

The Bank took a big step closer to declaring victory over inflation. The ECB staff projections for inflation were revised lower. Headline inflation is expected to average 2% in 2025, 1.6% next year and 2% in 2027. With inflation anchored around the ECB’s 2% target in the medium term, this should give the green light for further rate cuts.

Another reason the ECB may be wary about cutting rates further is its nuanced  growth outlook. The Bank kept its expectation for growth steady for 2025, even in the face of tariff risks. The ECB still expects the currency bloc’s economy to expand by 0.9% this year, which reflects a stronger performance in Q1, although growth could moderate for the rest of this year.

Tariff uncertainty ties ECB hands

The ECB also provided scenario analysis which explains their thinking about tariff risks to the Eurozone economy. A negative outcome to the US/ EU trade talks could lead to weaker than expected inflation, and a substantial downward revision to growth, however, a benign outcome to the trade talks where tariffs are lowered could lead to stronger growth, but also stronger inflation.

Since the EU and the US have not yet reached a trade agreement, what the ECB does next will be determined by what this agreement looks like and the trade relationship between the US and the EU going forward.

Germany could do the heavy lifting for the ECB going forward

Christine Lagarde said that the ECB is well positioned to navigate the tariff uncertainty. The current thinking at the ECB seems to be that the base for growth in the currency bloc remains strong now that Germany is willing to boost fiscal spending, and this could cancel out some of the tariff risks.

Going into this meeting, the market was convinced that there would be one further rate cut in September,  and we do not think that today’s meeting will change this. The market is still expecting a rate cut in September, and the market now expects rates to end 2025 at 1.66%, up from 1.6% before the meeting. The ECB’s statement was light on forward guidance. The Bank stuck to the same language it has used in recent months; it said that it remains data dependent.

Lagarde confirms her commitment to the ECB

Christine Lagarde was also asked about her future at the Bank. This was one of the first questions asked, and she was very clear that she was determined to complete her term. This suggests that she will be at the helm of the ECB for the next 2.5 years, and the jump in the euro could be a reaction to Lagarde clearly expressing her commitment to the ECB.

The market reaction

The market reaction to this meeting has been merged with the reaction to news that President Trump and Chinese premier Xi held a phone call, which suggests that the US and China are working towards cutting a trade deal. However, there is stil no deal so the market reaction is muted. Disputes around tech exports are holding up a decision, which could be weighing on risk sentiment on Thursday. US stocks are now lower, while European stocks are weaker across the board.

Christine Lagarde has boosted the euro; the euro is one of the stronger performers in the G10 FX space so far today. EUR/JPY is higher by 0.7%, while EUR/USD is higher by 0.6% and is now less than 100 pips below the April high of 1.1570, which is key short-term resistance.