The European Central Bank (ECB) has reduced interest rates once again, marking its sixth consecutive cut as economic conditions remain fragile. On Thursday, the ECB lowered its key rate by 25 basis points to 2.5%, a widely anticipated move given sluggish growth and cooling inflation across the eurozone.
However, the future trajectory of monetary policy is becoming increasingly uncertain. A significant shift in Europe’s fiscal landscape is underway, as leaders across the region ramp up military spending, driven by geopolitical tensions and evolving security concerns. Germany, long a proponent of fiscal restraint, is now preparing to ease borrowing limits to fund defense and infrastructure projects. This pivot marks a departure from over a decade of tight budgetary policies.
At a press conference in Frankfurt, ECB President Christine Lagarde acknowledged the fast-moving economic and political environment, noting that policymakers are closely monitoring the impact of increased government spending. While higher expenditures could stimulate economic growth, they also pose potential inflationary risks. The ECB remains cautious, assessing whether these fiscal decisions could influence price stability in the long run.
The reaction in financial markets has been swift. Government bond yields have surged, particularly for long-term debt, as investors price in the prospect of higher public borrowing. Meanwhile, stock markets have responded positively, with Germany’s DAX reaching record highs. The euro has also strengthened against the U.S. dollar, reducing inflationary pressures from imports.
Despite these developments, internal divisions persist within the ECB’s Governing Council over the extent to which rates should be lowered. Policymakers are aiming for a neutral stance, where monetary policy neither restricts nor stimulates economic activity excessively. However, determining this level remains challenging, with no clear consensus on when the bank should pause its easing cycle.
On Thursday, the ECB signaled that monetary policy was becoming “meaningfully less restrictive,” suggesting that further rate cuts may be limited. Traders are currently pricing in one more reduction, likely in April or June, though the ECB remains non-committal, emphasizing a data-driven approach to future decisions.
The eurozone economy has struggled in recent months, with weak consumer spending and muted business investment weighing on growth. While the ECB has aggressively cut rates by 1.5 percentage points since last summer, the economic response has been slower than expected. Growth projections have been revised downward, with forecasts now indicating a 0.9% expansion in 2025 and 1.2% in 2026.
Inflation, meanwhile, has continued to ease. February’s data showed a decline to 2.4%, down from 2.5% the previous month. Price pressures in the services sector, a key concern for policymakers, also moderated slightly. Nonetheless, the ECB now expects inflation to return to its 2% target slightly later than previously forecast, extending into early 2026 due to rising energy costs.
As Europe navigates this uncertain economic climate, the ECB remains cautious in its approach. While rate cuts have provided some relief, the impact of shifting fiscal policies and external risks, including potential U.S. tariffs, will continue to shape the region’s financial outlook. Lagarde’s message was clear: policymakers must remain flexible, as economic conditions can change rapidly.