By summer 2024, the European Central Bank (ECB) had significantly raised interest rates to combat high inflation. Since then, it has begun reversing course, lowering rates gradually. As of June 2025, the deposit rate stands at 2.0 percent – a level that can generally be seen as “neutral,” meaning it neither stimulates nor slows the economy.
Ahead of the next policy meeting on 24 July, many experts expect a pause of rate cuts. But the picture is complex, and caution remains warranted. The underlying drivers of core inflation, such as wage pressure in the services sector, remain persistent in some areas, economic momentum is fragile and geopolitical risks are increasing.
Key ECB interest rates (%)
Sources: ECB, Bloomberg.
Notes: Three month EUR Euribor Futures data is from 05/06/2025.
Inflation is at target level, but there is no green light
At first glance, everything looks good, with an overall inflation rate of 2 percent in June 2025 — the ECB's target. Falling energy prices are the main reason for this. However, a closer look reveals that core inflation, which excludes volatile energy and food prices, remains at 2.3 percent. It is driven by service prices, which react particularly slowly — for example, due to long-term contracts or rigid wage mechanisms. Although wage growth has slowed, at around 3 percent it is still above a level that is consistent with an inflation target of 2 percent.
Therefore, it is not yet possible to speak of sustained price stability. It remains to be seen what effect previous monetary policy measures will have in the long term, and how external factors such as new supply bottlenecks, will affect prices.
Harmonized Index of Consumer Prices (HICP) inflation in % and component contributions in the euro area (p.p.)
Source: Eurostat, author’s own elaboration.
Notes: In the euro area, core inflation excludes prices for energy, food, alcohol, and tobacco. e = estimated.
Interest rate easing meets balance sheet tightening
Interest rate policy is only one part of the overall monetary policy picture. The ECB is withdrawing liquidity from the banking system by reducing its balance sheet. This is mainly due to the phaseout of bond purchases, the conclusion of targeted long-term refinancing operations, and the conclusion of reinvestments in the Asset Purchase Program APP and the Pandemic Emergency Purchase Program PEPP.
This "quantitative tightening" can have a restrictive effect, even if the ECB lowers the key interest rate, for example, by causing long-term interest rates to rise or risk premiums for countries and companies to increase. Financing conditions remain tense despite falling key interest rates, creating a dilemma that challenges the ECB both communicatively and operationally.
Uncertainty as the new normal
The ECB is operating in an economic environment increasingly characterized by uncertainty. Global trade conflicts are impacting the eurozone by causing falling commodity prices, declining consumer confidence, and lower investment rates. The recent strengthening of the euro is also dampening inflation.
Conversely, national stimuli, such as the reform of the debt brake in Germany and increased defense spending by member states, have a potentially inflationary effect. While some eurozone countries are already experiencing inflation well below the target, others are struggling with persistent price pressure. These differing developments make monetary policy communication and management more difficult.
Communication is decisive
In 2022, the ECB abandoned its forward-looking approach in favor of a data-driven one. While this flexibility is understandable given the increased uncertainty, it comes at a price. It becomes more difficult for markets and the public to predict decisions. Individual statements by Council members gain disproportionate importance, and media interpretations often replace the ECB's original message. Therefore, the need for action is particularly evident in monetary policy communication. To counteract, the ECB could integrate various scenarios into its communication that depict key interest rates in relation to economic developments.
A transparent approach to forecasting uncertainty is equally important. Disclosing forecasting errors and communicating the lessons learned could strengthen confidence in the central bank's analysis. Credibility is a central bank's most important asset, especially in volatile times.
The situation ahead of the ECB interest rate meeting is complex. The ECB should continue its data-based approach with a sense of proportion. However, it is crucial that the ECB communicates its strategy clearly and comprehensively. After all, the effectiveness of monetary policy in the current environment depends not only on the level of interest rates, but also on clear and consistent communication.
More Analysis can be found in SAFE White Paper No. 113: Navigating Neutrality: ECB Policy Amid Heightened Uncertainty (prepared at the request of the European Parliament)
Michael Weber is Professor of Finance at the Purdue University Daniels School of Business and Research Affiliate at SAFE.
Blog entries represent the authors’ personal opinion and do not necessarily reflect the views of the Leibniz Institute for Financial Research SAFE or its staff.
