The battle between hawks and doves is intense! The European Central Bank is set to cut interest rates this week, but the future space for rate cuts has significantly narrowed

According to the Zhitong Finance APP, the European Central Bank is entering the final stage of its interest rate cut cycle, and the increasing internal policy divergence among ECB policymakers will complicate decision-making in the coming months, especially for the remainder of this year. Overall, a rate cut this week is considered a "high probability event," with the interest rate futures market widely expecting the deposit rate to be lowered by 25 basis points to 2.5% on March 6. However, this may be the last step that the 26 core policymakers of the ECB can easily reach a consensus on—debates over the magnitude and pace of subsequent rate cuts have recently become heated.

As borrowing costs approach the critical point where they no longer suppress the Eurozone's weak economy—the neutral interest rate expected by the market is around 2%, very close to the current official deposit rate set by the ECB—hawkish officials at the ECB have begun to challenge the market consensus of a drop to 2% by mid-year, with some officials stating that committee members should refrain from guiding market expectations for rate cuts.

Joachim Nagel, President of the German Bundesbank and a member of the ECB Governing Council, warned against "hasty actions," even going so far as to say in a speech that, amid persistently high inflation and increasing uncertainty, ECB monetary policy officials should best stop publicly discussing their preferences for the neutral rate.

Pierre Wunsch, Governor of the National Bank of Belgium, strongly reacted against "dreamlike rate cuts," opposing the idea of "thoughtlessly cutting rates to 2%." ECB Executive Board member Isabel Schnabel questioned whether current policies are still restrictive. The dovish camp insists on accelerating easing, with François Villeroy, Governor of the Bank of France, stating that "it is possible to reach 2% this summer," while Italian Executive Board member Fabio Panetta strongly advocates for aggressive rate cuts to counter any negative impacts from the ECB's significant balance sheet reduction.

Before the March policy meeting, hawkish members of the ECB Governing Council began to challenge the common basic view of economists that the deposit rate would steadily rise to 2% before mid-year.

Eurozone inflation data is starkly different: High inflation in Germany, significant cooling in Italy and France

The Eurozone inflation data for February is about to be released, with the stubborn 4% year-on-year growth in service prices still in focus. Although the ECB predicts inflation will return to the 2% target by 2025, the latest analysis from Wall Street financial giant Goldman Sachs indicates that the decisions in April and June will heavily rely on real-time data—if overall inflation exceeds expectations before the April meeting, rate cuts may be paused; conversely, easing will continue. A Bloomberg survey shows that about 25% of economists expect the ECB to hold steady in April, and market pricing also reflects hesitation.

The latest statistics released on Friday show that France's consumer prices rose only 0.9% year-on-year in February, significantly slowing from a 1.8% increase in January and below the general expectation of analysts at 1.1%. Italy's inflation rate remained at 1.7%, exceeding the market's general expectation of inflation rising to around 2% However, the inflation situation in Germany, the largest economy in the Eurozone, presents a different picture. In February, Germany's CPI rose by 2.8% year-on-year, exceeding the market's general expectation of 2.7%. More importantly, it increased by 0.6% month-on-month, significantly surpassing market expectations. In contrast, last month, Germany's CPI decreased by 0.2% month-on-month, indicating that inflation in Germany is quite "sticky" compared to Italy and France.

In addition, the return of Trump to the White House poses a dual risk with threats of increased tariffs on Europe and a surge in European defense spending. Lena Komileva, Chief Economist at G+Economics, warned of a "new stagflation shock": the trade war will squeeze limited policy space, while defense spending, although increasing sovereign bond supply, has a lagging inflation effect. The EU leaders' summit on March 6 in Brussels will coincide with the European Central Bank's monetary policy meeting, highlighting the urgency of policy coordination.

In a significant possible concession, Yannis Stournaras, a member of the European Central Bank and Governor of the Bank of Greece, indicated that officials may only conduct the last two rate cuts before autumn, suggesting a pause in rate cuts rather than a continuous reduction.

Jari Stern, Chief European Economist at Goldman Sachs, stated: "The increasing internal disagreements among European Central Bank policymakers mean that reaching a consensus on further rate cuts will certainly not become easier, which may lead to a slowdown in the pace of rate cuts. It seems possible to pause in April, but further reductions in the benchmark rate are still possible."

Interest Rate Path Divergence: 2.5% May Be the Midpoint Rather Than the Endpoint

Overall, the inflation data in the Eurozone presents very complex signals, but the European Central Bank still believes that the inflation rate will reach the 2% target by 2025, with clearer results expected when the EU statistics office releases February data on Monday. The focus will be on service prices, which have been rising at an alarming rate of about 4% for over a year in the Eurozone.

The European Central Bank has long predicted that the economy will eventually slow down as wage growth weakens. Kamil Kowal, an economist at Moody's Analytics, stated that evidence of this slowdown becoming a reality may become more significant in the coming months. He said: "In April and June, the European Central Bank may rely more on data points. If the inflation data before the April meeting is hot, then cuts will not happen. If the inflation data is weak, further rate cuts will occur."

A recent survey of economists showed that about 45% of respondents believe the terminal deposit rate will reach 2%, 39% expect it to drop to 1.75%, and around 17% anticipate it will decrease to 1.5%, with some economists even betting that the deposit rate will fall to 1%. Peter Schaffrik, a strategist at RBC Capital Markets, pointed out: "Calls for a pause in rate cuts will strengthen in the 2.5% to 2% range." The proposal by Governor Stournaras to "complete the last two rate cuts before autumn and pause in between" may become a compromise choice

Views on the European Central Bank's Interest Rate Path Deviation - Policymakers May Complete the Pause in Rate Cuts After Next Week

"The European Central Bank is almost certain to cut rates again on March 6. However, after that, resistance to further monetary easing within the ECB is strengthening. The most interesting aspect of the upcoming meeting of the ECB Governing Council may be any hints about what will happen next - the decision in April will be a delicate balance, but we expect an announcement to pause the rate-cutting process," said David Powell, senior economist for the Eurozone at Bloomberg Economics.

Another issue is whether U.S. President Donald Trump will follow through on his threat to impose tariffs on European goods. Due to a lack of details, the ECB has been reluctant to calculate any potential impacts, although officials have publicly acknowledged that economic growth will be severely affected.

"The consequences related to inflation rates are unclear. However, at least in the long term, upward pressure may prevail," said Lena Komileva, chief economist at G Plus Economics. "The Eurozone faces a new stagflation shock in the form of a trade war, with limited policy space and dispersed political will." "The ECB has little room for policy missteps."

There is significant divergence among central bank officials regarding the subsequent policy path of the ECB. Some officials are concerned about service sector inflation, rising energy prices, and macroeconomic uncertainty from U.S. tariff risks. If the cost increases from tariffs initiated by Trump are significant and difficult to absorb, European companies are more likely to pass those costs onto consumers, thereby driving up prices. Another group of officials is more worried about the economy being too sluggish and the recession risks implied by inflation being below target.

Complicating matters further, after Trump clearly stated that the U.S. would no longer guarantee Europe's security, fiscal spending—especially defense-related spending—may increase. EU leaders will discuss their options in Brussels on Thursday, while the ECB will formulate monetary policy in Frankfurt.

However, while this move may push sovereign bond yields higher with increased supply, any inflation impact seems to be some way off. This is because the economic effects of military spending differ from spending specifically aimed at stimulating activity, partly due to the flow of funds to overseas industrial companies, and because funding will not be in place overnight. Nevertheless, the substantial spending brought about by defense will inevitably impact inflation expectations.

Joerg Kukies, appointed by Scholz as Germany's Minister of Finance last November, stated that the country's lawmakers may push for a significant increase in Germany's defense spending before the new parliament is sworn in next month Peter Schaffrik, a global macro strategist from Royal Bank of Canada Capital Markets (RBC), stated: "Overall, considering the recent inflation rates and slowing wage growth in the Eurozone, they are likely to cut interest rates again in April. However, between 2.5% and 2%, the calls within the European Central Bank to pause rate cuts will become increasingly louder."