The European Central Bank is expected to continue its rate cutting cycle in 2025. Analysts are expecting moderate cuts of 0.25 percentage points each, probably in each of the four rate monetary policy meetings in the first half of the year, though some questions linger about their overall magnitude amid geopolitical uncertainties that may take a toll on eurozone inflation and growth.
“The ECB is expected to lead the way once again in 2025 with rate cuts,” said Michael Field, European market strategist at Morningstar.
“The market is currently pricing in 100 basis points of rate cuts, compared with only around half this level at a push for both the US Federal Reserve and the Bank of England. This of course hinges on inflation remaining under control in Europe. At 2.4% its the lowest of the three regions, but should this tick up any higher, then all bets are essentially off.”
ECB chief economist Philip R. Lane in a recent interview with Austrian newspaper Der Standard emphasized the necessity of a balanced approach to monetary policy to manage inflation without triggering a recession. He also said that the ECB will continue to make its monetary policy decisions data-dependent and will flexibly respond to economic developments, reiterating earlier statements by ECB President Christine Lagarde that the bank will not provide forward guidance.
The ECB began its rate-cutting cycle in June, paused in July, and resumed its rate adjustments in September; October and December. As of Dec. 18, the three ECB key interest rates stand at:
- Deposit facility rate: 3.00%
- Main refinancing rate: 3.15%
- Marginal lending facility: 3.40%
How Many ECB Rate Cuts Does the Market Expect?
After lowering rates by 100 basis points in 2024, the expected four or five additional cuts in 2025 would reduce the deposit rate to 1.75%- 2% by the end of the year.
DWS expects cuts of 0.25 percentage points each at the next four meetings of the ECB governing council in January, March, April and June. “The ECB will want to avoid making a mistake by acting too strongly and risk a loss of credibility,” Ulrike Kastens, European economist at DWS, told Morningstar on Jan. 13.
“I expect larger rate adjustments of 0.5 percentage points only if the economic situation in the eurozone worsens considerably,” she added.
DWS expects the terminal rate to reach 1.5%, but only in 2026.
Bastian Freitag, head of fixed income Germany at Rothschild & Co, also expects four rate cuts in 2025 in the baseline scenario. These cuts are likely to be gradual in 25-basis-point steps. He anticipates a data-driven and cautious approach by the ECB without any premature commitments, he told Morningstar in an interview on Jan. 10.
Is a Neutral Interest Rate Realistic?
Freitag views the discussion around the neutral or terminal interest rate, the level at which policy neither stimulates nor restricts growth, as a key topic for the first half of 2025. The neutral rate is estimated by the ECB to be between 1.75% and 2.5%, while Freitag sees the long-term neutral rate likely positioned in the range between 2% and 2.5%.
Amundi recently lowered its forecasts for the terminal interest rate to 1.75%. While there is uncertainty around the Fed, the ECB is expected to be more dovish due to inflation falling faster, the French asset manager wrote in its January 2025 Global Investment Views.
“We have decreased ECB’s terminal rate expectations by 50 bps to 1.75%, to be reached by July 2025,” the asset manager wrote. Amundi expects five cuts of 0.25 percentage points each at each of the five governing council meetings, including the one in July.
Why Are Bond Yields Rising As Rates Fall?
Despite falling ECB policy rates, bond yields in the eurozone have risen, influenced by factors like global market dynamics and US Treasury movements. This situation undermines the intended easing effect of rate cuts on credit conditions because higher bond yields mean higher borrowing costs for governments and enterprises, potentially slowing economic growth, Kastens said.
“This is a crucial feedback loop where the ECB’s efforts to stimulate the economy are partially offset by market-driven factors,” she told Morningstar.
German bund yields rose sharply in late 2024, with 10-year yields climbing from 2.02% in December to 2.65% in January 2025. This reflects rising US Treasury yields amid concerns about US fiscal policy, including potential tax cuts and rising debt levels, Kastens added. In addition, inflation in the eurozone and especially Germany has surprised to the upside.
Eurozone national central banks also halted their principal reinvestments as part of the ECB’s pandemic emergency purchase program (PEPP) at the end of 2024, said Shannon Kirwin, manager research analyst at Morningstar.
“The expiration of PEPP cuts demand, while at the same time many investors expect government bond issuance by Germany and France to increase going forward as the governments may increase spending, which ramps up supply.” Germany may ease its strict fiscal debt break after the country’s snap election on Feb. 23.
Kastens also noted that despite increased fiscal concerns, eurozone spreads have remained stable: “While the situation in France has drawn attention due to higher fiscal deficits and political instability, spreads between French and German bonds have not widened significantly yet. However, this remains a potential risk factor.”
A political crisis in France following failed budget reforms has raised concerns about public debt sustainability.
She also said that while spreads remain currently contained, the ECB’s Transmission Protection Instrument (TPI) provides a safety net. “Unlike during the sovereign debt crisis of the 2010s, the ECB has options to intervene,” she said.
Inflation in the Eurozone on Bumpy Path Downward
Headline inflation in the eurozone fell to 2.4% in December 2024, down from a peak of 10% in late 2022. Core inflation, driven by services, remains elevated at 2.7%. ECB’s Lane highlighted the challenge of reducing services inflation, which currently stands at 4%, for inflation to sustainably reach 2%.
The bank’s staff see headline inflation averaging:
- 2.4% in 2024 (down from 2.5% in the bank’s September forecast)
- 2.1% in 2025 (down from 2.3%)
- 1.9% in 2026 (down from 2.0%)
- 2.1% in 2027, when the expanded EU Emissions Trading System becomes operational. This is the first time the bank’s economist forecast for 2027.
For inflation excluding energy and food, staff project an average of 2.9% in 2024, 2.3% in 2025 and 1.9% in both 2026 and 2027.
Rothschild’s Freitag expects eurozone inflation to follow a bumpy trajectory, with fluctuations influenced by energy price volatility and geopolitical risks.
“Core inflation, especially in the services sector, remains resilient due to wage pressures but should gradually ease throughout 2025,” he said.
“In Germany, the CO₂ tax increase and rising public transport prices are significant contributors to inflation, while energy price dynamics, including gas price volatility, remain key factors to watch.”
Economic Slowdown in the Eurozone
The ECB’s gradual rate cuts in 2024 have drawn criticism from some economists. In a Financial Times survey, nearly half of 72 respondents said the central bank had “fallen behind the curve” and was too slow to help the eurozone’s stagnating economy.
The region’s growth prospects for 2025 remain fragile, with analysts warning that the potential imposition of tariffs by the Trump administration could further strain the region’s already weak economic momentum by disrupting trade and increasing costs for key industries.
Germany, the bloc’s largest economy, has stagnated for three years, reflecting structural weaknesses in manufacturing and energy-intensive sectors. The Bundesbank forecasts German GDP will shrink by 0.2% in 2025, contrasting sharply with other European economies. Spain is projected to lead economic growth among major eurozone economies with a GDP increase of approximately 2%.
Despite these headwinds, there are glimmers of cautious optimism among some analysts. Bastian Freitag of Rothschild & Co. anticipates a “slightly constructive outlook” for economic developments in 2025, with modest improvements expected. However, he warns of geopolitical and structural risks that could dampen growth, including tariffs.
ECB Staff’s Eurozone Growth Forecasts
- 0.7% in 2024 (down from 0.8% in September)
- 1.1% in 2025 (down from 1.3%)
- 1.4% in 2026 (down from 1.5%)
- 1.3% in 2027 (first estimate)
How Will Rate Cuts Affect Markets?
Equity markets tend to rise on anticipated rate cuts. In bond markets, falling interest rates mean lower yields, which pushes bond prices higher. Lower rates also make existing bonds, and particularly those already issued during a period of high rates, more attractive for yields.
Meanwhile cash savings rates on bank accounts will likely decrease, to the detriment of savers. The rates that savers receive depend mostly on the deposit facility, which defines the interest banks receive for depositing money with the ECB overnight. Borrowers, by contrast, benefit from lower rates as consumer debt and mortgages become cheaper.
“Lower rates should be a significant tailwind for European equities in 2025,” Morningstar’s Field said. European equities currently trade at an attractive discount relative to their US and global peers.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
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