ECB Policy Preview: Eurozone At Crossroads

The European Central Bank (ECB) is poised to announce its March policy rate decision, with a 25-basis-point cut widely expected, bringing the Deposit Facility Rate down to 2.5%. This move reflects the Eurozone’s relatively weaker economic performance compared to the United States, prompting a divergence in monetary policy. While the U.S. Federal Reserve has adopted a cautious stance amid stagflation concerns, the ECB remains focused on stimulating Eurozone growth, even with potential inflationary pressures on the horizon.

However, the ECB’s path is fraught with uncertainty. Potential U.S. tariffs, the formation of a new German government, the ongoing conflict in Ukraine, and a likely surge in public spending for European rearmament all contribute to a complex and unpredictable economic landscape. This confluence of factors complicates the ECB’s ability to accurately forecast and navigate its monetary policy.

Central to the ECB’s deliberations is the concept of the “neutral” interest rate, a theoretical benchmark that indicates when an economy is at full employment with stable inflation. Determining this rate, however, is a challenge, as it relies on various model assumptions and is difficult to pinpoint in real-time. Nevertheless, it serves as a crucial guide for policymakers in assessing whether current policies are restrictive or stimulative.

The anticipated rate cut is largely priced into markets, suggesting minimal immediate impact. However, alternative scenarios present contrasting outcomes. Should the ECB maintain the current rate, the euro could strengthen, and German bond yields could rise, potentially negatively impacting European equities. Conversely, a more aggressive 50-basis-point cut could trigger the opposite market reactions.

Adding another layer of complexity is the EU emergency summit, scheduled for the same day as the ECB decision. The summit will address the next steps for Ukraine and European security, a matter of paramount importance in the current geopolitical climate. Any indication of a potential resolution to the conflict could significantly influence energy prices, geopolitical risks, and overall economic confidence, thereby impacting the euro.

The ECB faces a delicate balancing act. While stimulating growth remains a priority, the central bank must also be vigilant against potential inflationary pressures and navigate a web of geopolitical and economic uncertainties. The coming months will be crucial in determining the direction of European monetary policy and the continent’s economic future.


ECB board hawk Isabel Schnabel’s typically detailed and data-packed speech in London last week laid out a case for being wary of excessive easing due to the elusiveness of the enigmatic R*.

The gist of her talk was that incoming lending data had cast doubt on how tight ECB policy actually is, meaning continual easing to address structural GDP weakness may be misguided.

And she concluded that uncertainty about just how high R* had risen of late meant there was a risk that the central bank would unintentionally lapse into stimulative monetary policy.

“The fact that growth remains subdued cannot and should not be taken as evidence that policy is restrictive.”

Even though Schnabel believes R* is still below levels seen before the banking crash 17 years ago, she said it had increased “appreciably” since before the pandemic and again since the 2022 Ukraine invasion – perhaps more than market prices suggest.

That, she said, was related to geopolitical supply shocks, rising public debt and withdrawal of central banks from bond markets as they reduced their balance sheets.

The ECB may need to tread very carefully after this next cut if higher public debt is a significant factor in the R* debate, as there’s little doubt that’s about to ratchet higher if Europe truly does re-arm.

The doves will fight back, of course, but the central banking battle lines are being drawn.