After 14 months of interest rates rising 10 times to record levels and another 9 months of remaining unchanged at those levels, it’s time to cut them.

Next Thursday, the European Central Bank is expected to cut the key deposit rate to 3.75% from 4% and the key refinancing rate to 4.25% from 4.5%, marking the start of their downward cycle.

The reduction in the refinancing rate will be the first after almost 10 years and specifically since September 2014. At that time, the specific rate was set at -0.20% from -0.10%, in a year when the ECB entered the period of negative interest rates and shortly after to quantitative easing to avoid the possibility of deflation in the Eurozone. This period is, of course, very distant and will probably not be repeated in the foreseeable future.

How much are interest rates expected to fall?

What we will probably see is ECB interest rates being gradually reduced until the second half of 2025, to a level of 2% – 2.5%, according to statements by ECB officials and economists’ estimates.

The speed and size of their reduction will depend mainly on the way inflation will decline – to 2% which is the ECB’s target – and secondarily on the general course of the economy, i.e. the speed of recovery.

The fact that there are still some doubts about the speed of the reduction in inflation – which in May rose more than expected to 2.6% – has “scissored” the expectations that existed at the beginning of the year for a faster reduction in interest rates.

Influential ECB officials such as Isabelle Schnabel, a member of the Executive Committee responsible for recommending monetary policy decisions, and Bundesbank President Joachim Nagel have publicly stated that they do not see it as appropriate to do it too soon, i.e. at the July meeting , the second rate cut. Therefore, it is likely that we will see a further cut, also by 25 basis points, in September and possibly a third one of a similar size in December.

When will mortgage installments be reduced?

The speed of the ECB’s interest rate reduction will also depend on when the reduction in installments will begin for those who have mortgage loans with a variable interest rate. The installments of these loans had been “frozen” by the banks since May 2023 – with the freeze valid, after its renewal this year, until May 2025 – based on the reference interest rate in force at the end of March 2023 minus 20 base units.

With the March 2023 ECB lending rate at 3.5% and the three-month Euribor – which is the benchmark for most floating-rate mortgages – just above 3%, loan installments “locked in » with Euribor below 3%.

After March 2023, the ECB made four more rate hikes, with the three-month Euribor currently standing at 3.8%.

Therefore, the ECB’s key interest rates would need to be cut five times, if the cuts are of the order of 25 basis points each (or less if the cuts are larger), for those borrowers to benefit financially. On today’s data, it is most likely that the reduction of rates will start in 2025 and will be completed in the same year depending on the level where the key ECB interest rates will stabilize.