ECB cuts rates to 2.5% and signals policy becoming meaningfully less restrictive

The European Central Bank cut its deposit facility rate by 25 basis points to 2.5% on Thursday, the sixth reduction since the easing cycle began in June last year. The move was fully priced by markets. What caught attention was the accompanying language: the Governing Council now says monetary policy is becoming "meaningfully less restrictive", replacing the word "restrictive" used as recently as January. That change, subtle on paper, has been read across Frankfurt and London as a signal that the pace of easing may slow.

A shift in language that matters

Central bank communication is rarely accidental. When the ECB describes its stance as "restrictive", it implies rates are still actively damping demand and that further cuts are the baseline. "Meaningfully less restrictive" suggests the policy rate is approaching neutral, the level that neither stimulates nor restrains. Jack Allen-Reynolds at Capital Economics called it a hawkish shift, writing that policymakers are clearly becoming more cautious about further reductions. Morgan Stanley economists took a different view: they still expect cuts in April and June but see the new wording as setting the stage for a pause in July.

Lagarde said the decision followed a "substantive discussion" and that no governor opposed the cut, though one abstained. She did not name the abstaining governor. The unanimity of the vote, minus that single abstention, contrasts with the more fractious debates of late 2023, when several governors argued publicly for keeping rates higher for longer.

Inflation: headline down, domestic still sticky

The backdrop to the decision is an inflation picture that is improving on the surface but remains complicated underneath. Eurostat data published earlier this week showed headline inflation at 2.4% in February, down from January but slightly above consensus forecasts. Core inflation, which strips out food, energy, alcohol and tobacco, also dipped after months of stickiness. Services inflation, the component most closely watched for signs of entrenched price pressures, eased as well.

The ECB's own staff projections, released alongside the decision, tell a more nuanced story. Headline inflation is now seen averaging 2.3% in 2025, up from the 2.1% projected in December, driven by stronger energy price dynamics. The 2026 forecast stands at 1.9% and 2027 at 2.0%. The bank reiterated that the disinflation process is "well on track" and that most measures of underlying inflation suggest a sustained return to the 2% target. But it added a caveat: domestic inflation remains "high".

Growth forecasts cut as trade uncertainty bites

If inflation is moving in the right direction, growth is not. The euro area economy expanded by just 0.1% in the fourth quarter of 2024, according to Eurostat. The ECB's staff have marked down their projections: 0.9% growth for 2025, down from 1.1% in December; 1.2% for 2026; 1.3% for 2027. The bank explicitly attributed the downgrade to "lower exports and ongoing weakness in investment, in part originating from high trade policy uncertainty as well as broader policy uncertainty".

That trade policy uncertainty has a name: Donald Trump. The US president has repeatedly threatened tariffs on European imports, though none have yet been formally announced. Lagarde warned that an escalation would lower euro area growth by dampening exports and weakening the global economy. She also flagged that ongoing uncertainty about global trade policies could drag investment down further. Geopolitical tensions, including Russia's war in Ukraine and the conflict in the Middle East, remain additional sources of uncertainty.

Defence spending and German fiscal plans: a work in progress

European leaders are simultaneously pushing to increase defence spending, spurred by the souring of US-Ukraine relations and questions about American security guarantees. The EU's ReArm Europe plan and a proposed fiscal shift in Germany, potentially relaxing the debt brake, were discussed at the Governing Council. Lagarde described both as a "work in progress" and said the bank would form conclusions on their growth and inflation impact when details emerge. She added, however, that there was clarity around the table that both would be supportive of European growth at large and a boost to the economy.

The interaction between fiscal expansion and monetary policy is the live question for the second half of 2025. A meaningful German fiscal stimulus, if it materialises, could raise the neutral rate and reduce the need for further ECB cuts. Conversely, if the US imposes broad tariffs, the growth hit could argue for faster easing. The ECB's new meeting-by-meeting, data-dependent framework is designed precisely for this kind of uncertainty.

Data dependence, not forward guidance

Asked directly by CNBC's Annette Weisbach whether the bank would hold rates steady in April, Lagarde declined to be drawn. "If the data indicates to us that in order to reach [our] destination, the appropriate monetary policy should be to cut we shall do so, but if on the other hand the data indicates that it is not the case, then we shall not cut, and we will pause," she said. "So that's really where we are: not precommitting, being data dependent, as ever, and deciding on a meeting by meeting basis."

That stance is a departure from the clearer forward guidance the ECB offered during the hiking cycle and the early months of easing. It reflects a Governing Council that no longer shares a single view on the path ahead. The hawks, led by governors from the north, want to see more evidence that services inflation is sustainably declining. The doves, more prevalent in the south, worry that growth is too weak to withstand a premature pause. The new language, "meaningfully less restrictive", is the compromise: it acknowledges progress without promising the next step.

What the data must show before April

Between now and the 17 April meeting, the Governing Council will receive two flash inflation prints (March and April), the March composite PMI, and a raft of national labour market and industrial production data. The March inflation figure, due on 1 April, will be the first test of whether the February dip in core and services inflation holds. Wage growth data, due in late March, will inform the domestic inflation picture. The ECB's own wage tracker has shown negotiated wage growth running above 4% year-on-year, a level the bank has said is consistent with 2% inflation only if productivity picks up or profit margins compress.

On the growth side, the March PMI will indicate whether the manufacturing recession is bottoming out. The February composite PMI came in at 50.2, barely in expansion territory. A reading below 50 in March would reinforce the case for another cut. Meanwhile, the European Commission's spring forecast, due in May, will incorporate the latest trade policy assumptions, assuming, that is, that US tariff policy has become clearer by then.