Europe: Approaching neutral interest rates, policy guidelines may be adjusted
2025-02-03
■ The European Central Bank (ECB) decided to cut interest rates for four consecutive meetings and hinted that it may continue to cut interest rates in the future.
■ As the neutral interest rate level gradually comes into view, the future natural interest rate and inflation outlook will become the focus of attention.
At the Council meeting on the 30th, the European Central Bank (ECB) decided to lower the limit of the policy interest rate guidance target, namely the central bank deposit facility rate (DFR), by 0.25 percentage points, and set the policy interest rate target range (corridor) between 2.75% and 3.15%. The statement content on the future policy guidance has not been modified, and it continues to insist on deciding the appropriate level and duration of tightening based on data at each meeting. As with the meeting in December last year, this statement did not include the tightening tendency of "maintaining the policy interest rate at a level sufficient to curb the economy as long as necessary", which shows that the ECB's interest rate cut policy has not changed. The future policy interest rate will still be determined based on the upcoming economic and financial data, core inflation trends, and the impact of the transmission strength of monetary policy on prices. At the press conference of ECB President Lagarde, she also avoided making a clear statement on the specific interest rate path.
The ECB expects core inflation to trend downward due to slower wage growth. In addition, economic growth driven by tourism consumption last summer is losing momentum while PMI data show that manufacturing activity is shrinking and service industry activity is expanding at a slower pace. So, the ECB is more cautious about the downside risks to the inflation outlook. Based on these insights and forecasts, the ECB stated that it would continue to cut interest rates, however, it did not make a clear statement on whether it would lower interest rates to a level below the neutral rate, nor did it give any relevant clues.
Regarding the criteria for stopping interest rate cuts, the natural interest rate has become the focus of attention. ECB staff will publish the latest natural interest rate estimates on February 7. The minutes of the Governing Council meeting on December 12 last year pointed out that due to the extremely high uncertainty of models and parameters, the estimates can only serve as a rough reference standard for monetary policy. The ECB confirmed that it will adopt a gradual approach to assess whether the policy interest rate has reached the neutral interest rate level considering the lag in policy transmission. If the interest rate is reduced by another 0.25 percentage points, it is possible to revise the perception that "monetary policy still has a suppressive effect on the economy" in March, which shows that the ECB already believes that the current interest rate is close to the neutral level. Before reaching the neutral interest rate level, the ECB is expected to continue to cut interest rates in the current manner. Once the neutral level is reached, it is necessary to comprehensively assess the deviations from the economic and inflation outlook to decide whether to cut interest rates further. Therefore, the natural interest rate estimate released on February 7 will become an important basis for judging the future policy interest rate path.
In addition, according to the ECB staff macroeconomic forecast in December last year, inflation is expected to return to the target level after the second quarter of 2025 (April-June). The inflation forecast updated in March will also become an important reference factor for judging when the interest rate cuts will stop and the final interest rate level and the market is expected to pay close attention to this.
■ As the neutral interest rate level gradually comes into view, the future natural interest rate and inflation outlook will become the focus of attention.
At the Council meeting on the 30th, the European Central Bank (ECB) decided to lower the limit of the policy interest rate guidance target, namely the central bank deposit facility rate (DFR), by 0.25 percentage points, and set the policy interest rate target range (corridor) between 2.75% and 3.15%. The statement content on the future policy guidance has not been modified, and it continues to insist on deciding the appropriate level and duration of tightening based on data at each meeting. As with the meeting in December last year, this statement did not include the tightening tendency of "maintaining the policy interest rate at a level sufficient to curb the economy as long as necessary", which shows that the ECB's interest rate cut policy has not changed. The future policy interest rate will still be determined based on the upcoming economic and financial data, core inflation trends, and the impact of the transmission strength of monetary policy on prices. At the press conference of ECB President Lagarde, she also avoided making a clear statement on the specific interest rate path.
The ECB expects core inflation to trend downward due to slower wage growth. In addition, economic growth driven by tourism consumption last summer is losing momentum while PMI data show that manufacturing activity is shrinking and service industry activity is expanding at a slower pace. So, the ECB is more cautious about the downside risks to the inflation outlook. Based on these insights and forecasts, the ECB stated that it would continue to cut interest rates, however, it did not make a clear statement on whether it would lower interest rates to a level below the neutral rate, nor did it give any relevant clues.
Regarding the criteria for stopping interest rate cuts, the natural interest rate has become the focus of attention. ECB staff will publish the latest natural interest rate estimates on February 7. The minutes of the Governing Council meeting on December 12 last year pointed out that due to the extremely high uncertainty of models and parameters, the estimates can only serve as a rough reference standard for monetary policy. The ECB confirmed that it will adopt a gradual approach to assess whether the policy interest rate has reached the neutral interest rate level considering the lag in policy transmission. If the interest rate is reduced by another 0.25 percentage points, it is possible to revise the perception that "monetary policy still has a suppressive effect on the economy" in March, which shows that the ECB already believes that the current interest rate is close to the neutral level. Before reaching the neutral interest rate level, the ECB is expected to continue to cut interest rates in the current manner. Once the neutral level is reached, it is necessary to comprehensively assess the deviations from the economic and inflation outlook to decide whether to cut interest rates further. Therefore, the natural interest rate estimate released on February 7 will become an important basis for judging the future policy interest rate path.
In addition, according to the ECB staff macroeconomic forecast in December last year, inflation is expected to return to the target level after the second quarter of 2025 (April-June). The inflation forecast updated in March will also become an important reference factor for judging when the interest rate cuts will stop and the final interest rate level and the market is expected to pay close attention to this.