The European Central Bank (ECB) has confirmed its fourth rate cut of 2025, setting the refinancing rate at 2.15% and the deposit rate at 2.0%.
It’s not over yet. With inflation finally in line with its targets, the ECB has the necessary leeway to lower its key rates once or twice more in 2025. The objective: to lend a helping hand to a faltering economy.
This is a welcome assistance, but it will not be enough to revive our economies.
Price stabilization: mission accomplished
The ECB can declare victory. The fall in European inflation to a level aligned with its 2.0% target (1.9% in May) signals that it has completed its price stabilization mission.
Admittedly, visibility remains limited, and doubts persist regarding the impact of U.S. tariffs on inflation.
Key interest rates may have further cuts
For some, they encourage increased competition in global markets and a price war, which would lower inflation. For others, the threats posed by globalization and growing protectionism will ultimately impact production chains, making them less efficient in the future and resulting in higher costs (and prices).
Both are possible in the short term, depending on the sector and the existence of viable alternatives to existing products and networks. In the medium and long term, we should not underestimate the adaptability and innovative capacity of producers or even consumers.
In any case, the current level of inflation allows our monetary authorities to continue lowering key interest rates.
Cheaper credit in the second half of 2025 and beyond would be good news for our economies.
Impact could be immediate
It encourages spending and investment by the private sector as a whole.
The effect is immediate in countries where variable-rate loans are highly popular (often aligned with short-term rates such as Euribor).
In these markets, it leads to lower monthly mortgage payments, leaving households with slightly more disposable income, which helps boost certain sectors, including construction and real estate.
Good news for exports
This is added to by the impact on the euro. With the Fed keeping its rates unchanged, the interest rate differential separating the two regions is expected to widen further, weakening the less profitable euro.
There is also a relief for European exporters who complain about our currency's renewed strength on the foreign exchange markets when U.S. tariffs undermine their competitiveness.
But it is not a silver bullet
However, we must face the facts. Additional rate cuts will not magically solve all the problems affecting the eurozone.
First, monetary policy works best when it supports fiscal and budgetary policy. However, on this front, hopes of seeing significant measures are low.
One-third of European Union countries are affected by excessive budget deficit procedures. Therefore, most European countries have no room for manoeuvre to adopt more lax fiscal policies or tax giveaways.
Of course, exceptions exist, and not insignificant ones. Under Friedrich Merz, Germany is preparing to experience a surge in public spending. However, competitiveness problems remain real, and Asian competitors continue to innovate. As a result, the German economy is expected to have a difficult 2025, barely managing to stay afloat. The yield curve is changing.
Less impact on long maturities
Then there’s the question of the impact of key rate cuts. While they allow the ECB - like other central banks - to influence interest rates on short maturities, they have less impact on long maturities.
And for good reason: before tying up their capital for long periods, investors are concerned about the inflation trajectory and seek a level of return that will offset it.
However, in this highly competitive market, they also consider the risks involved. Therefore, they compare the yields offered by different issuers, as well as their debt trajectory and ability to repay in the future.
Currently, debt is rising sharply almost everywhere. Whether in Europe, the United States, or Asia, deficits are swelling, and capital requirements are ever greater. And when U.S. debt - the cornerstone of the global financial system - offers relatively high yields, all global debt is asked to follow suit. Otherwise, it will struggle to find buyers.
As a result, 10-year bond yields in most European countries are trading at levels higher than those of early 2024, when the ECB's key rate was still 4.5%. In the immediate future, the various national Treasuries are moving toward a greater share of shorter-term debt issues, allowing them to finance themselves more cheaply.
However, this forces even more recurrent debt refinancing and reduces the system's resilience in the event of a potential shock. Therefore, a return of central banks to the debt markets cannot be ruled out if the trajectory of long-term rates remains upward.
The U.S’ upper hand
However, the United States has considerable advantages in this game. First, the country has long lived with more expensive credit than what we know in Europe, but this doesn't prevent it from maintaining a completely different dynamism, the result of greater competitiveness and flexibility.
Second, the decision to return to the debt markets would simply be up to the Fed, whereas in Europe, any prospect of a return to the ECB’s markets would be subject to endless political haggling.
Without reforms, struggles continue
With inflation finally under control, the ECB can manage economic recovery. However, its ability to do so should not be overestimated.
Without major reforms, for which politicians and voters show little appetite, Europe will continue to struggle to stay afloat in a world where its competitiveness is declining.
Admittedly, the stock market offers lower valuations than the U.S. markets. But the outlook is bleak and likely to remain so. We continue to invest in individual stocks.
See our latest portfolio here.
The ECB Refinancing Rate
(In %)
With inflation under control, the ECB can lower its rates further in 2025. But the impact of its actions should be put into perspective.