The European Central Bank delivered on its promise to cut interest rates but left investors querying where policy is headed next by also saying it will take longer for inflation to reach two per cent.

While Thursday’s quarter-point reduction in the deposit rate from its nine-month peak at four per cent was widely expected, the upward revision to next year’s forecast for consumer-price growth — to 2.2 per cent from two per cent — came as more of a surprise.

President Christine Lagarde noted that the inflation outlook has improved “markedly” and said there’s a “strong likelihood” that the ECB is shifting into a “dialing-back phase.” But she declined to confirm that such a change of gear has now happened.

While investors are still betting the ECB will lower rates again this year, the timing of that reduction is once again being questioned — with some already saying that cutting rates when inflation is still running hot puts the ECB’s credibility in doubt.

Traders went from betting on two additional moves this year to favouring just one. A cut in September is seen as the most likely outcome but confidence on that has waned.

“Going forward, for the ECB’s credibility they will need to hold a very, very neutral stance,” Vasileios Gkionakis, senior economist and strategist at Aviva Investors, told Bloomberg Television. “The bar for gaining more confidence has increased.”

He questions whether — in light of the stubborn price pressures — the ECB’s cut would even have arrived had officials not touted it for months in advance. 

The announcement was “almost exclusively driven by it being far too embarrassing for the Governing Council to back-pedal” on their pre-commitment, Gkionakis said. “It doesn’t make sense.”

This week’s decision begins to roll back the unprecedented barrage of hikes deployed to quell the euro zone’s worst-ever spike in prices. The step, which nudges the ECB ahead of the U.S. Federal Reserve and the Bank of England in loosening monetary policy, could also help to reinvigorate the 20-nation economy after two years of stagnation and a mild recession.

But it comes on the back of data releases — including May inflation, early-year wage rises and recent private-sector business activity — that came in higher than anticipated. Labour costs will continue to fluctuate in the near term, according to Lagarde.

“Inflation in Europe hasn’t been on a neat downward trajectory, echoing the same awkward policy and credibility dilemma faced by the Federal Reserve,” said Julian Howard, lead investment director and head of multi-asset solutions at GAM Investments.

What Bloomberg Economics says...

“The ECB tried to communicate its discomfort with elevated cost pressures, even though the Governing Council decided to reduce interest rates by 25 basis points today. President Lagarde hinted at a pause in July and the potential for more action in September, although she refrained from providing any clear indications on the timing for the cut.”

—David Powell and Jamie Rush, economists.

While people familiar with the matter are all but excluding a second cut in July, and some are questioning a September move, Lagarde did little to clarify when interest rates may next be adjusted.

“Are we today moving into a dialing-back phase? I wouldn’t volunteer that,” she told reporters in Frankfurt. “There’s a strong likelihood but it will be data dependent, and what is very uncertain is the speed at which we travel and the time that it will take.”

She also cautioned against paying too much attention to predictions from her Governing Council colleagues. “We know the path we are on but we also know there will be other bumps on the road,” she said.

They include meeting the inflation target later than planned, with the ECB’s latest quarterly outlook showing it will moderate to two per cent in the third quarter of 2025, rather than in the middle of that year as previously thought.

The revision adds to the “sticky inflation story that may limit the room for additional rate cuts,” said Theophile Legrand, a rates strategist at Natixis SA.

Nicolas Forest, chief investment officer at Candriam, goes further.

“This initial cut may not signal the start of a sustained easing cycle,” he said. “On the contrary, the new guidance remains cautious, avoiding any clear direction on future moves.”