ECB Interest Rate Cuts Considerations

FRANKFURT (Reuters) – The European Central Bank (ECB) highlights that it may still need to cut interest rates further to boost economic growth, as stated in a recent paper. Despite this, the ECB played down the relevance of their latest estimates.

The optimal neutral or natural deposit rate, which avoids stimulating or restricting growth, is now estimated to be between 1.75% and 2.25%. This estimation has remained relatively stable in recent years, differing from a previous range of 1.75% to 2.5% provided by ECB President Christine Lagarde last December.

Such a figure may indicate more rate cuts could be forthcoming due to weak economic performance hampering inflation and hindering the ECB from achieving its 2% inflation target, which it has surpassed for the past four years.

However, the ECB emphasized the speculative nature of this new estimate, claiming that neutral rates cannot be precisely measured and involve a significant level of uncertainty. The bank stated, “The inherent uncertainties as well as conceptual shortcomings limit the usefulness of available natural rate estimates for conducting monetary policy in real time.”

Recent months have seen increased focus on the neutral rate after several ECB officials indicated this would be an important target moving forward, coinciding with the removal of the phrase about maintaining a “sufficiently restrictive” policy.

The latest estimates suggest a need for two more cuts to reach the upper limit of the neutral rate estimation range, while investors are anticipating three to four additional cuts within the year due to concerns over sluggish growth.

Additionally, the ECB noted that the neutral level, referred to as “r*” in central bank parlance, has not markedly shifted post-pandemic, contrary to some analyses. The ECB stated, “Following a modest post-pandemic increase, the updated range of point estimates of the real natural rate of interest for the euro area has remained broadly unchanged since the end of 2023 and is consistent with the estimates documented.”

While some members of the ECB board have proposed their own neutral rate ranges as potential guiding benchmarks for policy, others have downplayed any specific figure. Board member Piero Cipollone stated, “Neutral is a very powerful analytical concept but not terribly useful for setting monetary policy due to this embedded uncertainty.”

Chief economist Philip Lane reiterated that numerous factors determine the restrictiveness of policy, and these cannot be encapsulated by a single indicator.