Goldman Sachs Expects ECB to Continue Rate Cuts with Policy Shift

Goldman Sachs, in its recent assessment of the European Central Bank's (ECB) monetary policy, provided forecasts regarding the bank's future interest rate decisions. This analysis follows the ECB's implementation of consecutive 25 basis point rate cuts in the fourth quarter and its shift towards a more forward-looking approach in policy-making.

The investment bank updated and expanded its model based on three policy criteria: inflation outlook, core inflation, and the strength of monetary policy transmission. Utilizing data since the second quarter of 2003, this model shows that, during the interest rate hike cycle and the initial phase of rate cuts, the ECB's Governing Council places greater importance on core inflation rather than staff inflation projections.

However, in the fourth quarter of 2024, a policy shift was observed, consistent with a reduction in errors in staff inflation forecasts. This change in the ECB's reaction function is associated with the Council's decision to proceed with successive rate cuts and aligns with the recent statements of ECB President Christine Lagarde.

Goldman Sachs' findings indicate that the high dependency on core inflation data significantly influences the ECB's decisions to raise and subsequently lower interest rates. Looking ahead, the bank foresees limited impact on the future interest rate path due to (a) core inflation measures approaching the 2% level and (b) projections indicating inflation will hover slightly below 2%.

Nevertheless, a return to a forward-looking policy approach will enable the ECB to respond more swiftly to economic shocks. Assuming a return to pre-pandemic averages in evaluating the ECB's policy criteria, Goldman Sachs' model anticipates that consecutive 25 basis point rate cuts will continue, consistent with its projections.

The analysis concludes that, barring a noticeable decline in growth outlook or a significant reduction in inflation projections, the current rebalancing in the ECB's policy approach alone does not necessitate an acceleration of rate cuts to 50 basis points.