ECB cuts deposit rate to 2% as trade war clouds eurozone outlook

The European Central Bank has lowered its deposit facility rate to 2%, marking the eighth consecutive quarter-point cut since the easing cycle began in June 2024. The decision, announced on Thursday, brings the cost of overnight bank deposits in the eurozone to less than half the equivalent rate in the United Kingdom, where the Bank of England holds its policy rate at 4.25%, and well below the Federal Reserve's target range of 4.25% to 4.5%.

Inflation finally below target

The immediate trigger for the cut was May's inflation reading. Annual consumer price growth across the 20-member currency bloc fell to 1.9%, dipping under the ECB's 2% medium-term target for the first time since September. Energy and food price volatility continue to distort the headline figure, but the decline gave the governing council cover to keep cutting even as domestic price pressures, particularly in services, remain stickier.

Christine Lagarde, the ECB president, told reporters in Frankfurt that the vote was "virtually unanimous", with only a single council member arguing for a pause. She characterised the decision as a recalibration rather than a panic move, though she acknowledged the unusual speed of the easing cycle, eight cuts in twelve months is the fastest in the bank's history.

Trade war casts long shadow

The backdrop to every ECB meeting since early 2025 has been the escalation of trade tensions initiated by the Trump administration. Tariffs on European steel, aluminium and automotive exports have begun to filter through order books, particularly in Germany and Italy. The ECB's own staff projections now assume a measurable drag on business investment and export volumes over the next two quarters.

"While the uncertainty surrounding trade policies is expected to weigh on business investment and exports, especially in the short term, rising government investment in defence and infrastructure will increasingly support growth over the medium term," the bank said in its policy statement. The reference to defence spending reflects the rearmament plans announced by Berlin, Paris and Rome in recent months, which are only now starting to appear in national budgets.

Growth split between manufacturing and services

Lagarde highlighted a divergence in the real-time data. Manufacturing surveys have shown tentative improvement in recent weeks, possibly reflecting front-loading of orders before tariffs bite. The domestically focused services sector, which accounts for roughly 70% of eurozone output, is losing momentum. Retail sales volumes fell 0.4% in April, and consumer confidence remains below its long-term average despite rising real wages.

"A strong labour market, rising real incomes, robust private sector balance sheets and easier financing conditions … should all help consumers and firms withstand the fallout from a volatile global environment," Lagarde said. The unemployment rate stood at 6.3% in April, a record low, and negotiated wage growth slowed to 3.8% in the first quarter from 4.7% a year earlier, progress on the ECB's domestic inflation gauge.

Analysts divided on the terminal rate

Financial markets currently price roughly two more quarter-point cuts by the end of 2025, implying a deposit rate of 1.5%. Deutsche Bank's Mark Wall thinks the ECB may need to go further if the trade war intensifies. "The trade war is inherently unpredictable. The inflation undershoot could deepen and persist," he said. By contrast, Irene Lauro at Schroders argues the bank can afford patience. "The stable outlook meant the ECB can afford to shift from urgency to patience," she noted.

The ECB's own macroeconomic projections, updated in March, see inflation averaging 1.6% in 2026 before returning to 2% in 2027. Those forecasts predate the latest round of US tariff announcements and assume a gradual recovery in global trade. Several council members have privately expressed concern that the baseline is already outdated.

Lagarde quashes departure rumours

The press conference was dominated as much by personnel speculation as by policy. Reports in the German business press had linked Lagarde to discussions about succeeding Klaus Schwab at the World Economic Forum after his abrupt departure last month. She dismissed the chatter directly. "You are not about to see the back of me," she said, confirming her intention to serve the full eight-year term that expires in October 2027.

The episode underscores the political dimension of the ECB presidency. Lagarde's background, French finance minister, IMF managing director, makes her a natural candidate for other international roles, but her insistence on staying removes a near-term source of uncertainty for markets. The next appointment will be a joint decision of EU heads of state and government, likely to become a focal point of Franco-German negotiations in 2026.

Comparison with UK and US highlights divergence

The transatlantic gap in policy rates is now the widest since the euro's launch. The Bank of England cut to 4.25% in May but has signalled a slower pace thereafter, citing persistent services inflation and a tighter labour market. The Federal Reserve has held since December, with Chair Jerome Powell repeatedly stating that the US economy does not yet need easing. Donald Trump has attacked Powell publicly, most recently on Tuesday when he demanded a rate cut after weak private payroll data from ADP.

For the eurozone, the rate differential has helped keep the euro relatively weak against the dollar, providing a modest cushion for exporters. However, a sharply weaker currency would risk reigniting import-price inflation, particularly for energy. The ECB's trade-weighted exchange rate index has fallen about 4% since January, a move the bank watches but does not target.