ECB Urged to Keep Forward Guidance Amid Limited Rate Cut Room

The European Central Bank (ECB) should retain forward guidance as a policy tool, according to the Traders Union. With the euro area's natural real interest rate near zero and the nominal neutral rate at 2%, the ECB has less room for standard rate cuts compared to the Federal Reserve.

This structural gap gives forward guidance a more important role in Europe as a substitute for conventional easing when policy is constrained. The ECB's inflation target is at 2%, leaving it with limited room to lower rates before policy loses effectiveness.

The Traders Union argues that the ECB's 2021 policy framework, designed after periods of low inflation and rates near the lower bound, has proven resilient through the pandemic, energy crisis, and recent inflation volatility. This framework supports retention of forward guidance, which is also emphasized in the ECB's 2025 strategy review.

The Traders Union warns against turning guidance into a rigid commitment, citing the example of 2022 when earlier ECB communication linked rate increases to the end of net asset purchases, before the governing council delivered a larger first rate rise than it had signalled only weeks before as inflation accelerated.