ECB to cut interest rates again, signal further easing as growth falters

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) -The European Central Bank is all but certain to cut interest rates again on Thursday and signal further easing in 2025 as inflation across the euro zone is nearly back at target and the economy is faltering.

The ECB has already cut rates at three of its last four meetings. Nevertheless the debate has shifted to whether it is easing policy fast enough to support an economy that is at risk of recession, facing political instability at home and the prospect of a fresh trade war with the United States.

That question is likely to dominate Thursday's meeting but policy hawks, who still command a comfortable majority on the 26-member Governing Council, are likely to back just a small, 25-basis-point cut, taking the benchmark rate to 3%, nearly all economists in a Reuters poll said.

In a possible compromise with more dovish policymakers, the cut could come with tweaks to the ECB's guidance to make clear that further policy easing is coming provided there are no new shocks to inflation, which could ease to the central bank's 2% target in the first half of 2025.

"The already restrictive policy stance, the deteriorating growth outlook, and inflation at target should all speak in favour of a 50 basis point cut," Danske Bank economist Piet Haines Christiansen  said.

"From a communication perspective, I think it is easier to deliver a 25 basis point rate cut, keeping the optionality to deliver a jumbo cut if they see the need for it."

A cut is warranted because fresh projections will show inflation, above target for three years now, back at 2% in a few months' time. That is partly because economies are barely growing across the 20 countries that share the euro.

The outlook is so fraught with risk that some policymakers argue the ECB now risks undershooting its inflation target, as it did for nearly a decade before the pandemic, and should move more quickly to avoid falling behind the curve.

But hawks say inflation is still a risk given rapid wage growth and the fast-rising cost of services, so that a steady stream of incremental steps is appropriate.

U.S. protectionism and political instability in France and Germany are further reasons for caution.

Governing Council members simply do not know what policies will be approved by President-elect Donald Trump's new U.S. administration, how Europe will respond - or what the economic impact will be.

Political turmoil in France and Germany's upcoming election add to the uncertainty and could force the ECB to step in, reinforcing arguments that it should leave itself space to take bold action if needed, keeping its powder dry for now.

"There is a high risk that on the back of Trump, France and Germany, euro zone growth will come in much weaker than the ECB’s projections will show," ING economist Carsten Brzeski said.

"The only problem for the ECB to preemptively react to the current political woes is that it could be seen as intervening in national politics on behalf of France," Brzeski added.

STRING OF CUTS

Financial markets have fully priced in a 25 basis point rate cut on Thursday, with the odds of a bigger step now close to zero - a big change from a few weeks ago when a half percentage point cut was seen as a real possibility.

Investors then see a cut at every meeting until June, followed by at least one more move in the second half of 2025, taking the deposit rate to at least 1.75% by year-end.

Any change in the ECB's guidance for the future is likely to be at the margins.

It could drop its reference to needing "restrictive" policy to tame inflation, an implicit signal that rates will come down at least to the so-called neutral level at which they are neither stimulating nor slowing economic activity.

The problem is that neutral is an undefined concept and each policymaker has a different estimate, putting the range between 1.75% and 3%, with most seeing it between 2% and 2.5%.

But the ECB is likely to keep its intentions vague after having burned itself repeatedly by making explicit commitments that proved difficult or impossible to keep.

"With inflation on track to settle at the 2%  target next year, we think the ECB  will soon remove the reference to its intention to keep rates 'sufficiently restrictive'," UBS economist Reinhard Cluse said.

"We think the ECB will also cut rates by 25 basis points in each of the following four meetings, bringing the deposit rate to the broadly neutral rate of 2%  by June."

(Editing by Catherine Evans and Susan Fenton)