European Central Bank expected to cut interest rates again amid sticky inflation

• The European Central Bank is set to lower key rates by 25 bps at the January policy meeting.
• ECB President Christine Lagarde's words will hold the key to offering fresh policy cues.
• ECB policy announcements are expected to rock the EUR/USD pair and infuse intense volatility.

The European Central Bank (ECB) interest rate decision will be announced on Thursday at 13:15 GMT following the conclusion of the January monetary policy meeting. Markets are anticipating another reduction in key rates, marking a continuation of the easing cycle after December's rate cut. No updated staff economic projections will published at this meeting. 

ECB President Christine Lagarde will hold a press conference at 13:45 GMT, where she will deliver the prepared statement on monetary policy and respond to media questions. The ECB announcements will likely inject intense volatility around the Euro (EUR) against the US Dollar (USD).

What to expect from the European Central Bank interest rate decision?

After lowering key rates in December, the ECB is widely expected to announce another 25 basis points (bps) cut, taking the benchmark rate on deposit facility from 3% to 2.75%. It would be the fourth straight interest rates cut after trimming them in September, October and December 2024.

In December's post-policy meeting press conference, ECB President Christine Lagarde said that "risks to growth are tilted to the downside," while the "risk to inflation is now two-sided."

Speaking on the inflation and interest rate outlook in a CNBC interview last week, on the sidelines of the World Economic Forum (WEF) annual meetings in Davos, President Lagarde said: "We're confident Eurozone inflation will be at target over the course of 2025," adding that "gradual moves in rates come to mind at the moment."

Eurostat's preliminary data released on January 7 showed that the Eurozone Harmonized Index of Consumer Prices (HICP) rose 2.4% year-over-year (YoY) in December after reporting a 2.2% increase in November. The data aligned with the market forecast. The annual core HICP inflation held steady at 2.7% in the same period.

Eurozone inflation remained elevated and moved slightly from the central bank's 2.0% target in December. Economists at ABN Amro noted that "the rebound in headline inflation was driven largely by energy, with both the lower base from last year but also recent weakness in the Euro contributing to higher petrol prices, as well as higher gas and electricity prices with Europe running down its gas inventories somewhat faster than usual this winter. "

Subsequently, the accounts of the December ECB meeting published on January 16 showed: "There were still many upside and downside risks to the inflation outlook. More check points had to be passed to ascertain whether disinflation remained on track and kept open the optionality to make adjustments along the way."

Against this backdrop, the ECB's communication in the policy statement and President Lagarde's comments will hold the key to determining the scope and timing of the next rate cuts as the Bank battles concerns over economic growth and potential tariffs by United States (US) President Donald Trump's administration.

Previewing the ECB meeting, TD Securities analysts said: "This decision should be a fairly straightforward cut. Inflation data has been noisy but on net a touch weaker than expected in its December projections. Growth signs show no real signs of improving, either, adding to the soft backdrop." "We expect no real change in messaging around this one, but questions about the neutral rate are likely to crop up in the press conference," the analysts added.

How could the ECB meeting impact EUR/USD?

In the lead-up to the ECB showdown, the EUR/USD pair is hovering near last Friday's five-week high of 1.0522. The pair's further upside remains dependent on the outlook of ECB interest rates.

ECB President Christine Lagarde is expected to maintain the rhetoric that the Bank is not on any pre-determined path on interest rates and will likely remain data-dependent. Lagarde could also reiterate her view of "gradual moves in rates". In such a scenario, EUR/USD is set to extend the recovery momentum. However, the main currency pair could witness a fresh downtrend if Lagarde mentions that a 50 bps rate cut was discussed as an option in the meeting or expresses concerns over the economic prospects.

Dhwani Mehta, Asian Session Lead Analyst at FXStreet, offers a brief technical outlook for EUR/USD:

"Despite EUR/USD's recent corrective decline, the pair remains poised for further recovery as the Relative Strength Index (RSI) indicator managed to defend the 50 level on the daily chart. If buyers recapture the 50-day Simple Moving Average (SMA) at 1.0422 on a sustained basis, EUR/USD could make another run toward the 1.0500 level. Further up, the six-week high of 1.0533 will be challenged."

"If the downside regains traction, the immediate support of the 21-day SMA at 1.0355 will be tested. A fresh sell-off could be seen below that level, opening doors toward the 1.0300 round level. The last line of defense for EUR/USD buyers is seen at the January 17 low of 1.0265."