The European central bank (ECB) reduced interest rates by 25 basis point on Thursday, aiming to stimulate economic activity as the eurozone grapples with sluggish growth.
This move, which lowers borrowing costs for both consumers and businesses, comes amid mounting concerns about the impact of potential trade conflicts with the US and rising defence spending.
The ECB’s decision to cut its benchmark deposit rate to 2.5% is aimed at supporting the economy by making it cheaper to borrow for investment and consumption. The bank previously raised rates to a record 4% in response to inflation peaking at 10.6% in October 2022, but has been easing rates since June as inflation has since moderated to 2.4%, according to AP report.
Despite the decline in inflation, growth remains a pressing concern for the 20 nations using the euro. The eurozone’s economy showed zero growth in the final quarter of 2024, and the outlook for 2025 is uncertain due to shifting dynamics in global trade and the possibility of heightened defence spending.
ECB President Christine Lagarde, speaking after the meeting, emphasized that the rate cut would make borrowing conditions “meaningfully less restrictive” for the economy.
She cautioned that the central bank was not committing to a specific rate trajectory going forward, acknowledging the complexities presented by global trade tensions and increased government spending.
As economic uncertainty continues, Lagarde noted that increased defence and infrastructure spending could spur growth, but growing global trade tensions—particularly with the US—pose a major challenge to inflation expectations in the eurozone.
Economists, including Carsten Brzeski from ING Bank, pointed out that with increasing uncertainty and the possibility of large fiscal stimulus, the ECB’s future rate path is unclear. “A pause at the next meeting to reassess the economic landscape seems likely,” said Brzeski.
The new fiscal realities in Germany, the eurozone’s largest economy, have added another layer of complexity. A new government coalition has agreed to loosen budget restrictions to allow for significantly more borrowing, potentially injecting up to a trillion euros into defence and other sectors over the next decade. This shift in fiscal policy could stimulate growth, but may also lead to increased inflationary pressures.
Meanwhile, concerns are rising about US President Trump’s potential new tariffs on European goods, which could further hinder growth in the export-driven eurozone economy. The looming trade war adds another layer of uncertainty for businesses already wary of inflation and political shifts.
Despite these challenges, some analysts, like Julien Lafargue of Barclays Private Bank, expect the ECB to remain flexible, making future decisions based on incoming economic data. The central bank faces a delicate balancing act: boosting growth while managing inflationary risks, with external pressures such as US tariffs potentially complicating this task.
