Updated: Feb 11, 2025
The ECB has just published a highly anticipated study on the "neutral rate" or "r*", a level of short-term interest rates in the euro area that is neither expansionary nor restrictive.
This study and the publication of the corresponding rate level were highly anticipated because ECB governors increasingly refer to it.
During the last ECB press conference on January 30th, a journalist asked Christine Lagarde about the ECB's reaction function when this neutral rate is reached. Christine Lagarde responded: “ It’s a nice question. But let’s face it: we are currently restrictive. We are not at the neutral rate. This is a debate that is entirely premature. When we get closer to that, we will operate on the basis of a staff research paper, on the basis of the analysis provided by staff, and then that will help us determine how close we are and what our monetary policy stance should be”.
The neutral rate published on February 7th is a range between 1.75% and 2.25%, centered on a rate of 2%. This level corresponds to 2 to 4 additional rate cuts (of 0.25%) since the deposit facility rate was reduced to 2.75% at the end of January 2025.
Although ECB economists have taken care to write that "r* cannot be used mechanically to determine monetary policy, it is clear that this anchoring of the neutral rate at around 2% is an important compass for market expectations, at least in the coming months, especially since the ECB regularly refers to it.
This neutral rate level is rather at the lower end of expectations and contributes to some extent to the recent observed decline in long-term rates in the euro area.
On the day of this announcement, the forward curve of 3-month Euribor reached a low point of 1.97% at the end of 2025 (together with a peak at 2.58% in 2037) .
That said, let us remember that long-term rates in the euro area will remain highly dependent on longer-term growth and inflation expectations in the euro area and the evolution of long-term US rates, and that the definition of the neutral rate is intended to evolve over time based on multiple factors.
