The European Central Bank is almost guaranteed to cut rates. Here's what could happen next

The European Central Bank is widely expected to cut its key interest rate by 25 basis points to 2% on Thursday, driven by inflation nearing its 2% target and sluggish economic growth, with Q1 2025 GDP at 0.3%. Analysts anticipate further rate cuts later in the year, potentially starting as soon as July, but expect the ECB to avoid pre-committing to a specific policy path due to economic uncertainties, including potential U.S. tariffs and geopolitical factors; further rate cuts would likely lower borrowing and savings rates for consumers, though the impact on long-term fixed-rate products may be muted due to market expectations already priced in.

Analysis

The European Central Bank (ECB) is poised for an almost certain 25-basis-point interest rate cut this Thursday, bringing the deposit facility rate to 2%, a significant reduction from its mid-2023 high of 4%, as markets price in a 99% probability according to LSEG data. This anticipated monetary easing is underpinned by May's flash data showing euro zone inflation at 1.9%, aligning closely with the ECB's 2% target, and continued sluggish economic performance, evidenced by a mere 0.3% GDP growth in Q1 2025. Despite the expected cut, the future path of monetary policy remains highly uncertain due to several domestic and international factors, including potential U.S. tariffs under a Trump presidency, possible EU retaliatory measures, EU rearmament plans, and Germany's fiscal policy shifts. Analysts, including those from Barclays and BofA Global Research, foresee further rate reductions later in the year, possibly in September and December, but anticipate the ECB will adopt a cautious, meeting-by-meeting approach, refraining from strong forward guidance. Jack Allen-Reynolds suggests a subsequent cut could occur as early as July. The upcoming release of ECB staff projections for inflation and economic growth will be critical, especially following the OECD's forecast of 1% growth and 2.2% inflation for the euro area this year. For consumers, subsequent cuts would likely translate to lower short-term borrowing and savings rates, though the impact on long-term fixed-rate products may be limited as current market rates have largely priced in this week's anticipated cut.

Key Decisions for Investors

• Given the high probability of the initial 25bps cut being priced in, focus on the ECB's forward guidance and staff projections for insights into the future rate path and economic outlook.
• Monitor subsequent ECB communications closely, as the central bank is expected to maintain a data-dependent, meeting-by-meeting approach, creating potential for volatility around future policy decisions.
• Consider re-evaluating positions in rate-sensitive sectors and currencies, as further ECB easing, if signaled, could diverge from other major central bank policies, influencing relative asset performance.
• Factor in the heightened economic uncertainty stemming from potential U.S. tariffs and other geopolitical developments, as these could significantly alter the ECB's policy trajectory and impact euro zone growth prospects.