The European Central Bank (ECB) has cut interest rates again as inflation in the Eurozone slows and economic growth falters. However, no clear guidance was given on future actions, even though investors expect continued easing in the coming months. The deposit rate was lowered by 25 basis points to 3.5%, a move anticipated after a similar cut in June. Inflation is now nearing the ECB’s 2% target, while the Eurozone economy skirts the edge of recession.

Although this cut was widely expected, investors are now focusing on the next steps and how ECB policy might be influenced by the U.S. Federal Reserve, which is also expected to begin cutting rates soon. However, ECB President Christine Lagarde refrained from pre-committing to any specific rate path, emphasizing the bank's "data-dependent" approach, which considers multiple indicators before deciding on further action. She noted that inflation data in September might be skewed by statistical base effects.

Markets showed little reaction to the move or the lack of forward guidance, which analysts attributed to the ECB’s cautious stance. According to Carsten Brzeski, ING’s Global Head of Macro, the ECB is likely to proceed cautiously, given its poor track record in predicting inflation during its rise. The ECB wants to ensure it fully understands the situation before making further aggressive rate cuts.

Lagarde described the inflation situation in the euro area as mixed. While wages continue to rise, overall labor cost pressures are moderating. However, more cautious policymakers from southern Eurozone nations argue that high rates are now stifling growth, increasing the risk of an economic downturn. On the other hand, inflation hawks warn that the labor market remains overheated, and underlying price pressures, especially in services, could trigger another surge in inflation.

New forecasts from ECB staff showed a slight downgrade in economic growth for this year, while inflation is expected to return to target by the second half of next year. This leaves policymakers divided on the speed of future rate cuts, with hawkish members supporting quarterly reductions in line with updated growth and wage data.

Investors are similarly divided. While another rate cut by December is fully priced into the markets, the likelihood of an additional move in October fluctuates between 30% and 50%.

In addition to the deposit rate cut, the refinancing rate was lowered by 60 basis points to 3.65%, in what the ECB called a technical adjustment. The gap between these rates, previously set at 50 basis points since 2019, was narrowed to 15 basis points as part of an effort to encourage interbank lending in the future. Although this revival is still some years away, the adjustment aligns with the ECB’s long-term strategy. Currently, banks are holding €3 trillion in excess liquidity, making the deposit rate the ECB’s primary policy tool. As this liquidity diminishes, borrowing from the ECB at the refinancing rate should increase, restoring its role as the central bank’s benchmark.

Additionally, the marginal lending rate, a rarely used tool, was cut by 60 basis points to 3.9%.

ECB President Lagarde also addressed a recent report by her predecessor, Mario Draghi, which calls for sweeping reforms to strengthen the European economy. Lagarde described the report as “severe but just,” highlighting its diagnosis of Europe’s economic challenges. Draghi’s proposals include significant increases in industrial investment and innovation, which he argued are essential for Europe to remain competitive with the U.S. and China.

Lagarde praised the report, stating that the suggested reforms could significantly boost the ECB's ability to achieve its monetary policy goals. She pointed to increased productivity, deeper capital markets, and more funding for innovation as key outcomes that could benefit the central bank. Lagarde expressed hope that European authorities would take the report seriously and pursue the recommended structural changes.