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Finance
ECB Signals Further Rate Cuts as Inflation Eases, Bringing Sub-3% Borrowing Costs Into View
OL
Olivia Scott
2 weeks ago
The European Central Bank is laying the groundwork for an extended run of interest rate reductions, with policymakers increasingly confident that the worst of the eurozone’s inflation shock has passed. Market participants and economists now see a growing likelihood that the central bank’s main refinancing operations rate will fall below 3% by the end of 2026, a level that would mark a significant easing from the current cycle’s peak and provide fresh momentum to the bloc’s struggling economy.At its most recent policy meeting, the ECB held its key deposit rate at 3.5% after delivering a quarter-point cut in June, its first reduction in five years. The main refinancing rate, which serves as the benchmark for commercial bank liquidity, currently stands at 3.65%. While the central bank has stopped short of committing to a specific trajectory, President Christine Lagarde has repeatedly emphasized that future decisions will remain data-dependent, with inflation trends and wage growth acting as the primary guideposts. The latest inflation reading for the eurozone came in at 2.5% year-on-year, down sharply from the double-digit peaks seen in late 2022, and core inflation, which strips out volatile food and energy prices, has also moderated to 2.9%.The shift in the ECB’s stance reflects a broader reassessment across global central banks. The U.S. Federal Reserve has signaled that it too may begin cutting rates later this year, while the Bank of England has already reduced its benchmark rate once. For the eurozone, the case for further easing is bolstered by a fragile economic recovery. The bloc’s GDP grew by just 0.3% in the second quarter, with Germany, the largest economy, barely avoiding a contraction. Manufacturing output remains weak, and business confidence surveys have pointed to continued softness in the industrial sector. At the same time, the services sector has shown more resilience, supported by steady consumer spending and a robust labor market that has kept unemployment at a record low of 6.4%.A key factor in the ECB’s deliberations is the pace of disinflation in the services sector, which has been stickier than goods inflation due to wage pressures. Negotiated wage growth in the eurozone has remained elevated, running at around 4.3% in the first quarter, though there are early signs that pay increases are beginning to moderate. ECB officials have noted that corporate profit margins are absorbing some of the higher labor costs, which could help ease the pass-through to consumer prices. Still, the central bank’s own staff projections, released in June, see inflation returning to the 2% target only in the fourth quarter of 2025, a timeline that suggests policy will remain restrictive for some time.If the ECB does deliver the series of cuts that markets are pricing in, the main refinancing rate could dip below 3% by late 2026, a scenario that would have profound implications for households, businesses, and governments across the currency union. Lower borrowing costs would reduce the burden on mortgage holders and corporate borrowers, potentially unlocking investment that has been deferred during the high-rate environment. It would also ease the fiscal pressure on highly indebted member states such as Italy and Greece, which have faced higher debt-servicing costs in recent years. However, some policymakers have cautioned against moving too quickly, warning that premature easing could reignite inflationary pressures and undermine the credibility of the ECB’s inflation-fighting stance.The debate within the Governing Council is likely to intensify in the coming months as new data on wages, productivity, and energy prices become available. The ECB’s next policy meeting is scheduled for September, and while a rate cut is not a foregone conclusion, many analysts expect the central bank to resume its easing cycle before the end of the year. The path to sub-3% rates is not without obstacles, but the direction of travel appears clear: the era of ultra-tight monetary policy in Europe is drawing to a close, and the focus is shifting toward supporting growth without jeopardizing the hard-won gains on inflation.
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