As the European Central Bank (ECB) gears up for its next monetary policy meeting on January 30, markets are abuzz with speculation. UBS Research, led by economist Reinhard Cluse, anticipates a 25 basis point (bp) cut in the deposit rate, lowering it from 3.00% to 2.75%. The ECB has maintained a data-dependent, meeting-by-meeting approach, signaling a cautious yet flexible stance as it navigates uncertain economic conditions.

A Path to Neutral Rates by Mid-Year

UBS’s central scenario suggests the ECB is poised to continue easing policy through the first half of 2025. Following the January cut, the research team expects additional 25bp reductions in March, April, and June. This would bring the deposit rate to 2%, a level broadly considered “neutral” — neither stimulative nor restrictive for the economy.

The ECB’s careful pace reflects its balancing act: addressing elevated inflation while preparing for potential headwinds to growth.

Inflation Trends: A Temporary Peak?

Eurozone inflation remains a key concern for policymakers. Headline inflation climbed to 2.4% year-on-year in December, with core inflation — excluding volatile items like energy and food — hitting 2.7%. Despite these figures, UBS economists believe inflation has peaked and should trend downward.

Services inflation, however, is a sticking point, sitting at an uncomfortable 4.0%. While high, wage moderation is expected to take hold in the coming months, which could help alleviate upward pressure on prices.

Growth Risks Loom Large

The ECB’s outlook isn’t without its challenges. Should downside risks to Eurozone growth materialize, Cluse suggests the central bank may be forced to push rates below neutral, dipping under the 2% threshold.

One potential catalyst for further rate cuts could be U.S. tariffs on European goods, which UBS estimates could shave up to 0.75 percentage points off Eurozone GDP growth. Such a development would likely compel the ECB to adopt a more dovish stance.

All eyes will be on the ECB next week as it sets the tone for monetary policy in 2025. With inflation showing signs of easing but growth risks still in play, the central bank faces a delicate balancing act. Markets should brace for a cautious yet adaptive ECB, prepared to adjust its course as economic data unfolds.