### ECB Lowers Interest Rates as Euro Strengthens and Energy Costs Decline

In a pivotal move for the euro zone economy, the European Central Bank (ECB) announced a 25-basis-point reduction in interest rates on Thursday, marking a significant policy shift aimed at stabilizing inflation and supporting growth amid rising geopolitical tensions. This decision reduces the deposit facility rate to 2%, down from its mid-2023 peak of 4%, aligning closely with trader expectations who had priced in a nearly 99% probability of this outcome according to LSEG data.

The ECB has also revised its inflation projections. The latest economic outlook anticipates an average inflation rate of 2% in 2025, a downward adjustment from the March forecast of 2.3%. The ECB attributed this revision to lower energy prices and a stronger euro. Meanwhile, core inflation projections for 2023 were adjusted upwards to 2.4%, from the previous estimate of 2.2%.

Despite the rate cut, reactions in the market were mixed. The pan-European Stoxx 600 initially held steady but later dipped just below the flatline. The euro, however, saw a modest increase, trading 0.4% higher against the dollar following the announcement.

ECB President Christine Lagarde, during her press conference, acknowledged that the council's decision was influenced by the updated assessment of the inflation outlook and the dynamics of underlying inflation alongside the robustness of monetary policy transmission. She also disclosed that one member of the governing council did not support the rate cut.

Economic indicators show that the euro zone's inflation fell below the ECB's target rate, hitting 1.9% in May according to preliminary data, cooler than expected. In terms of economic growth, the euro zone expanded by 0.3% in the first quarter of 2025. The ECB has maintained its growth forecast for 2025 at 0.9%, despite a balanced view of a robust start to the year and a weaker overall outlook.

The ECB highlighted that while uncertainties in trade policies, particularly those stemming from U.S. President Donald Trump's tariff policies, might dampen business investment and exports, increased government spending on defense and infrastructure could bolster growth in the medium term. Tariffs specifically affecting sectors like steel and autos pose significant risks, although the impact on inflation remains ambiguous and contingent upon the European Union's retaliatory measures, currently on hold.

Looking ahead, the ECB provided little clarity on future rate changes, leaving analysts divided. While some argue for patience and stability in rates, others see a need for further cuts given easing inflationary pressures and persistent growth challenges. Irene Lauro from Schroders suggests a probable pause in the rate-cutting cycle, whereas Natasha May from J.P. Morgan Asset Management believes another rate cut is essential to ensure inflation targets are met amid ongoing trade tensions.

This decisive action by the ECB underscores the complex economic landscape and the delicate balance policymakers must maintain to navigate through uncertain times.