Fidelity: ECB approaches neutral interest rate level
Salman Ahmed, Global Head of Macro & Strategic Asset Allocation at Fidelity International, comments on today's ECB meeting:
'The European Central Bank (ECB) cut its key policy rates by 25 basis points at today's meeting, bringing the deposit rate to 2.5%, in line with expectations. The statement language regarding the restrictive stance showed a notable shift, with the ECB stating 'monetary policy is becoming meaningfully less restrictive', signalling they recognise the transition away from a tight policy stance is well underway.
Updated staff projections show a slight downgrade to near-term growth, minor changes to core inflation, and mechanically higher headline inflation for 2025 reflecting mostly the rise in energy prices between projection rounds. The Governing Council maintained that the disinflation process is 'well on track' and noted that 'most measures of underlying inflation suggest that inflation will settle at around the Governing Council's 2% medium-term target on a sustained basis'. They acknowledged that 'domestic inflation remains high', but emphasised that 'wage growth is moderating as expected'.
During the press conference, President Lagarde stressed that risks to growth remain to the downside but acknowledged that increased fiscal spending could see stronger growth than expected. 'Defence and infrastructure spending could raise inflation', she added. She explained that the change in statement language regarding restrictiveness was to acknowledge the substantial progress made towards neutral, while emphasising they are still not pre-committing to any particular rate path. Considering her recent European Parliament remarks where she placed the neutral rate in the 1.75-2.25% range, today's comments suggest the ECB views itself as nearing—but not yet having reached—neutral territory.
Looking ahead, that the ECB now sees interest rates as 'meaningfully less restrictive' was a strong hint that they could pause at the next meeting and thus we now see April as a 50/50 decision that will depend heavily on incoming data and whether President Trump's anticipated April 2nd tariff announcements include significant measures targeting Europe.
The impact of recently announced fiscal stimulus on ECB policy is more nuanced as several offsetting factors are at play: potential growth is likely increasing (which makes stronger growth less inflationary), defence spending has high import content and thus low multipliers (limiting a potential fiscal impulse), bund yields are surging (which is growth-negative in ECB models), and the euro is appreciating (which is disinflationary). Additionally, the timing of fiscal implementation means a meaningful positive impulse is unlikely before 2026.
We now anticipate the ECB will aim for the lower end of the neutral range (around 1.75%) rather than moving into accommodative territory. This reflects our view that while fiscal announcements give the ECB room to potentially pause in April (barring aggressive tariffs on Europe), they will still want to position monetary policy to support economic recovery given ongoing downside risks from potential trade disruptions. Markets are now pricing less than two more cuts this year and a terminal rate of ~2.1%, so we maintain a more dovish outlook, though not as dovish as before this week's fiscal announcements.'
