Will ECB’s policy rate remain neutral?

The Eurozone’s CPI rose to 2.1% in August 2025, slightly above both July’s pace and market expectations of 2.0%, preliminary data showed. So, many analysts expect the market to be even more convinced that the Bank has finished its easing cycle. ECB members appear to be validating this view; claiming that the bar to another rate cut is quite high.

An ECB discussion of the neutral rate says that measures of the neutral rate are typically constructed as an equilibrium value towards which interest rates tend to gravitate in the medium to long term, as aggregate saving and investment imbalances abate and inflationary or disinflationary pressures that may have developed as a consequence of those imbalances dissipate”.

Now this does not mean that the neutral rate is one number, or even within one range necessarily, as the neutral rate can change over time. It is also not observable and, according to some, not necessarily a very useful concept. But let’s for the moment assume that it is reasonably useful and reasonably stable. If so, is the 1.75%-2.25% range the sort of area that the ECB should be aiming for when it comes to the end of this easing cycle? If it is, then it looks as if the ECB’s work has been done. However, one way to look at this issue is to see where policy rates have been in the past.

Steven Barrow, Head of Standard Bank G10 Strategy, thinks this is useful because, it turns out, that inflation has pretty much averaged 2% in the twenty five years that the ECB has been operating monetary policy. Some might question whether twenty-five years is sufficient time to come to any sort of definitive conclusion but we’d note that, over this period the deposit rate has been around a half of the average inflation rate at just over 1%. Now he would not wish to claim that just because the policy rate has averaged almost a full percentage point below the ECB’s neutral rate mid-point that the bank’s estimate is way out of line.

For a start, this twenty-five year period has seen a number of hugely negative shocks like the global financial crisis, the pandemic and Russia’s invasion of Ukraine; all factors that have meant that the ECB has had to push the deposit rate far below the neutral rate, even below the zero lower bound. But right now, the eurozone is still coming to terms with another shock which is the imposition of punitive tariffs by the US Administration.

With this in mind, growth estimates remain pretty meager. Growth at the moment is an annual 1.4%; no higher than the average we’ve seen since the start of EMU, and the ECB sees full 2025 growth at just 0.9% and 1.1% in 2026. Putting all this together Steven Barrow suspects that the ECB has more wood to chop when it comes to easing policy. A 25-bps rate cut seems likely this year and he expects to see a follow-up 25-bps cut early next year to take the deposit rate down to 1.5%. This may prove to be the final resting point for the key rate in this easing cycle, although we’d still be hesitant to regard 1.5% as absolutely the lowest the deposit rate can go.

Could such an outlook harm the euro if correct? In Steven Barrow’s view, that’s certainly possible, particularly as no rate cuts are fully discounted by the market right now. However, the saving grace could be that the Fed will likely be cutting rates as well and these cuts will undoubtedly occur in an environment where the political neutrality of the Fed comes into question. An issue that, thankfully, is not prevalent in the eurozone.