ECB Monetary Policy

Yesterday, my ECB Governing Council colleagues and I reduced policy rates by 25 basis points, or a quarter of a percent.  

This is the sixth reduction since June 2024, bringing the Deposit Facility Rate (the rate through which the Governing Council steers the monetary policy stance) to 2.5%.

The decision to lower rates is based on our assessment that inflation continues to move towards our 2% target, warranting an easing in our policy stance.

Updated ECB staff projections show that headline inflation in the euro area is expected to average 2.3% this year, falling to 1.9% in 2026 and 2.0% in 2027. This is a slightly higher near-term path for inflation than previously expected, owing to higher energy prices. Core inflation – that is, excluding volatile energy and food prices – is expected to average 2.2% in 2025, 2.0% in 2026 and 1.9% in 2027.

Turning to growth, the growth outlook for the euro area is weak: GDP is expected to increase by just 0.9% in 2025, 1.2% in 2026 and 1.3% in 2027 which represents a downgrade from previous projections, in large part because heightened levels of economic uncertainty. This is expected to delay business investment, dragging down domestic demand. The projections have a recovery in consumer spending as the main growth driver of near-term growth, with real wage growth providing a boost to incomes.

Despite the growth slowdown, the labour market remains resilient. Although employment growth is slowing, unemployment is projected to remain around its historic low of 6.3%. Given the importance of consumer spending for the growth outlook, I will be watching closely for the emergence of any increase in risks to the unemployment rate. For example, a sharp fall-off in job openings in those sectors most exposed to trade frictions, such as manufacturing.

Encouraging signs in recent inflation outturns, but risks remain

For the euro area, headline inflation is developing broadly in-line with expectations, registering 2.4% in February, down from 2.5% in January.

In Ireland, headline inflation fell to 1.3% in February, from 1.7% in January. We will publish updated projections for the Irish economy in our first Quarterly Bulletin of 2025 in the coming weeks.

Higher energy commodity prices in recent months are feeding into euro area inflation, but this is offset by weaker developments in core inflation.

Services inflation, accounting for almost two-thirds of the core-spending basket (the rest is spending on goods), fell to 3.7% in February, having been stuck around 4% for the past year. This is good news: as I have said previously, to be consistent with our 2% medium-term target, we need to see lower services inflation. The ongoing easing of wage growth momentum in the euro area, which has evolved broadly in-line with staff projections in recent months, should support services disinflation.

Higher than expected energy prices at the beginning of the year are being offset by lower than expected services and food inflation, leaving overall projections broadly on-track. Goods inflation has been running well-below long-run levels for several months at around 0.4 - 0.6% (although the updated projections have this rising to 0.8% in the coming months). 

Policy-making and uncertainty

Inevitably and unfortunately, the economic outlook is shrouded in uncertainty. In this environment, it makes sense for policy to proceed cautiously. It is clear that, following a 1.5% reduction in our interest rates since last June, our monetary policy is becoming meaningfully less restrictive. With borrowing less expensive for households and firms, loan growth is picking up.  

This rising uncertainty is why our Monetary Policy Statement yesterday emphasised once again our intention to follow a data-dependent and meeting-by-meeting approach to deciding the appropriate monetary policy stance, while also not pre-committing to a particular rate path. This allows us to retain maximum optionality to respond to events that could derail our path to achieving 2% inflation over the medium-term.  

The main uncertainty relates to US trade policy and actions taken in response that could further escalate geopolitical frictions. Facing such uncertainty, firms could postpone investment and re-assess their labour demand. ECB staff baseline projections downgraded the investment component of domestic demand to reflect this.

Depending on the size and scope of any tariffs, there is also the potential for amplified effects on inflation, output and employment. We saw during the pandemic how upstream frictions could disrupt supply chains, feeding quickly through to prices (although the underlying demand conditions at the time were arguably stronger than they are now). Another downside risk is that a reversal of labour hoarding could lead to higher unemployment.

Furthermore, the projected consolidation of public finances will need to be revised given recent announcements to increase security-related spending. I will follow these developments closely to understand their impact on the growth and inflation outlook. 

Overall, the rapid pace of change means we must be cautious, prudent and humble in our assessment of the potential impact of what are, in some cases, unprecedented policy shifts.  

Conclusion

The uncertain environment we are facing is not just a risk for growth and inflation but also has implications for regulatory and supervisory risks, as noted in the Regulatory and Supervisory Outlook that we published last week.

One difference with the current period, compared to previous episodes, is that uncertainty stems primarily from geopolitical developments rather than emanating from the financial sector. Measures of trade and economic policy uncertainty have jumped, with possible implications for financial stability including increased market volatility and a sudden repricing of risk.  

This is why we on the Governing Council have decided to maintain our meeting-by-meeting, data-dependent approach to setting monetary policy. Our next monetary policy meeting is in April.

Gabriel Makhlouf