• The ECB’s fourth 25bp rate cut of the year came in dovish packaging with clear signs of confidence on the inflation outlook. We assume that the current pace of easing will continue and rates will be taken down to a neutral mark of around 2%. It’s not a pre-determined path – the ECB has already proven it is following a data-dependent approach – and risks are tilted towards a faster pace of easing (i.e. a 50bp cut) in the new year.
• US trade policy is the obvious risk, but it’s still unclear that any announcement of US tariffs, if limited in scope, would in itself be an acute shock which triggers more forceful action. Over the short-term, a rise in protectionism would likely add to inflationary pressures (mostly through retaliatory measures) which would raise uncertainty and make it harder to find a consensus to accelerate rate cuts unless other data (e.g. inflation, wages, growth) were to surprise on the downside as well over coming months.

Another cut, and the direction of travel is clear

The ECB cut interest rates for the fourth time in 2024 – in line with our expectations at the start of the year (see here) – bringing the deposit rate to 3%. It was a fairly dovish package. While Lagarde said the 25bp move had been a unanimous decision, she acknowledged that there had been some discussion about the possibility of a bigger 50bp move. There were also significant changes to the statement language. First, the reference to keeping rates “sufficiently restrictive as long as necessary” was removed from the guidance. Second, it was noted that “the disinflation process is well on track” and “most measures of underlying inflation suggest that inflation will settle at around the Governing Council’s 2% medium-term target on a sustained basis”.

This is confident-sounding stuff, with the ECB more or less saying it believes the job is done on inflation now. The main (and perhaps only) area of lingering concern relates to elevated wage growth and services inflation, but the policymakers still suggest that this is related to the ongoing adjustment to the 2021-22 inflation shock. There were encouraging signs of fading services momentum in the latest data (Chart 1).

Looking ahead, Lagarde acknowledged that “the direction of travel currently is very clear” and we continue to expect back-to-back 25bp cuts to bring rates towards a neutral setting. On that topic, Lagarde again mentioned the ECB’s research earlier this year on the topic (see here). That report doesn’t give an official ECB figure but does present a range of other estimates which centre around 2% nominal, which is in line with our view at MUFG.

But it’s not a case of autopilot and the ECB is keen to preserve flexibility against a backdrop of high uncertainty. The credibility of its meeting-by-meeting, data-dependent setting was highlighted in October when, following a slew of dovish news, policymakers moved to cut rates again (there was no indication of that intention at the previous meeting just five weeks earlier). So, while we continue to think that the ECB favours sticking to a gradual approach to rate cuts, we accept that risks are tilted towards a larger 50bp move early next year.

Chart 1: Price momentum in services has faded sharply

Chart 2: Sentiment has weakened post-US election

How would the ECB respond to new US tariffs?

Trade policy is the obvious risk to the outlook. The ECB’s updated projections saw a downward revision to the 2024 and 2025 growth figures. Prior to any official announcements these projections do not directly account for the risk of US policy changes. While Trump has not yet mentioned tariffs on the EU, our assumption remains that the US will impose some tariffs on EU goods next year and these will hinder what is still a fragile euro area recovery. Accordingly, we see growth at 0.9% in 2025, versus the ECB’s updated projection of 1.1%.

However, we question whether the ECB would be minded to move quickly in response to an announcement on tariffs, primarily because the inflationary consequences are far from clear. Lagarde herself said yesterday that tariffs are “probably net inflationary” over the short term, presumably due to the assumption of retaliatory tariffs and a weaker currency. Yes, some policymakers would look past this sort of one-off price level shock (especially given well-anchored inflation expectations in the euro area) but the assumption of higher near-term price pressures will make it harder to find a consensus to accelerate rate cuts. On growth, we also suspect that the waters could be muddied by a short-term boost to euro area exports as US firms look to build inventories prior to any new tariffs.

Further ahead, our view is that the impact of weaker demand following any new US tariffs and uncertainty around their future path will ultimately dominate, and hence push inflation lower. But there is likely to be a sizeable lag before this becomes clear in the data, and until that became the case (perhaps not until 2026) there would likely be hawkish resistance to rates being moved into accommodative territory.

For now, the bottom line is that the ECB seems on course to neutral, but in the absence of an acute shock – and we’re not sure limited US tariffs would be categorised as such – it might be hard to find a consensus to get there faster unless other data (e.g. inflation, wages, growth) were to surprise on the downside as well over coming months.

Chart 3: The ECB sees core inflation falling swiftly next year

Table 1: GDP & Inflation projections