In a recent assessment of the European Central Bank's (ECB) monetary policy, Goldman Sachs provided insights into the central bank's future interest rate decisions. The analysis follows the ECB's move to implement consecutive 25 basis point rate cuts in the fourth quarter and a shift towards a more forward-looking approach in policy setting.
The investment bank updated and extended its model, which is based on three policy criteria: the inflation outlook, underlying inflation, and the strength of monetary policy transmission.
This model, which uses data since the second quarter of 2003, suggests that during the rate hiking cycle and initial rate cutting phase, the ECB's Governing Council emphasized underlying inflation over staff inflation projections.
However, a shift in policy was noted in the fourth quarter of 2024, aligning with a decrease in errors in staff inflation forecasts. This change in the ECB's reaction function correlated with the Governing Council's decision to step up to sequential rate cuts and is in line with recent comments from ECB President Christine Lagarde.
Goldman Sachs' findings indicate that a high reliance on underlying inflation data significantly influenced the ECB's decisions to raise and then lower rates. Looking ahead, the bank foresees a limited impact on the future rate path due to (a) underlying inflation measures nearing the 2% mark and (b) projections that see inflation settling slightly below 2%.
Nonetheless, a return to a forward-looking policy approach would allow the ECB to react more swiftly to economic shocks.
Assuming the ECB reverts to pre-pandemic averages in weighing policy criteria, Goldman Sachs' model anticipates the continuation of sequential 25 basis point rate cuts, consistent with their forecast.
The analysis concludes that without a notable decline in the growth outlook or a substantial reduction in inflation projections, the current rebalancing of the ECB's policy approach alone would not warrant an acceleration of rate cuts to 50 basis points.
This article was generated with the support of AI and reviewed by an editor. For more information see our T&C.