ECB Cuts Rates on Weaker Growth Prospects; Further Fed Relief Contingent on Labor Market Performance, Inflation

The European Central Bank (ECB) opted to continue with rate reductions, lowering the deposit rate from 2.75% to 2.50%, the sixth reduction in nine months.?

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Growing the divide between borrowing rates overseas and in the U.S., the ECB saw the move as “necessary” to guard against the prospect of weaker domestic activity amid potential fallout from U.S. tariffs, as well as a recent need to increase military spending.

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While not yet enacted, the latest decision by Germany, the region’s largest economy, to increase defense and infrastructure funding by as much as €1 trillion ($1.08 trillion) has dramatically adjusted expectations for growth and inflation, adding to the volatility of global financial markets.

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According to the ECB statement, “The economy faces continued challenges and staff have again marked down their growth projections – to 0.9% for 2025, 1.2% for 2026 and 1.3% for 2027. The downward revisions for 2025 and 2026 reflect lower exports and ongoing weakness in investment, in part originating from high trade policy uncertainty as well as broader policy uncertainty.”

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The euro is up 0.3% against the U.S. dollar, currently trading at $1.08 as of 9:36 a.m. ET.

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Meanwhile, back in the U.S., the prospect of further Fed relief remains an increased probability in the second half of the year, with market players pricing in 2-3 rate cuts by year-end potentially taking the federal funds rate to a low of 3.75%. The prospect of such action, however, is rooted in fears of emerging weakness in the domestic economy, and specifically, the U.S. labor market, which failed to materialize in the aftermath of earlier rate cuts last year. Instead, accelerating inflation over the past several months has seemingly solidified the Committee’s position on the sidelines, at least for now, or at least until the recent ascent in price pressures is arrested or a more meaningful indication of labor market weakness is identified.?

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Speaking of labor market weakness, or lack thereof, U.S. jobless claims fell 21k to 221k in the week ending March 1, reversing from an earlier rise of 22k last week. The four-week average, meanwhile, held steady at 224k. On the other hand, continuing claims, or the total number of people claiming ongoing unemployment, increased from 1.855M to 1.897M in the week ending February 22, marking an almost three-year high.

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On the weaker side, yesterday, ADP reported that private-sector employment rose by just 77k in February, falling significantly short of the 140k gain expected and the smallest monthly increase since July. According to the report, the weaker-than-expected rise is largely a reflection of job cuts in the service sector as well as inclement weather tapping down hiring, specifically in the Southern and Western regions of the United States.

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The key data point, however, will be released tomorrow. Following a weaker-than-expected rise of 143k in January, the February nonfarm payrolls report is expected to show a gain of 160k, potentially marking a two-month high.?

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The unemployment rate, meanwhile, is expected to remain steady at 4.0% in February now for the second consecutive month.

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Additionally, average hourly earnings are expected to rise 0.3% in February and 4.1% year-over-year, matching the annual increase in January.

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Looking beyond the labor market, yesterday, MBA mortgage applications rose 20.4% in the week ending February 28 following two consecutive weekly declines. The 30-year mortgage rate, meanwhile, dropped 15bps to 6.73%, near a three-month low.

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Additionally, the S&P Global U.S. Services PMI was revised up from 49.7 to 51.0 in the final February print, albeit still marking the lowest reading since November 2023, and the Composite PMI was revised higher from 50.4 to 51.6 in the final February print, still the lowest reading since April 2024.

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Meanwhile, the ISM Services Index unexpectedly increased 0.7 points from 52.8 to 53.5 in February, a two-month high and the eighth consecutive month in expansion (a reading above 50). According to the median forecast, the index was expected to decline slightly to 52.5 in the second month of the year.

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In the details of the report, employment rose 1.6 points to 53.9, the third consecutive monthly increase and the highest reading since December 2021, supplier deliveries inched up 0.4 points to 53.4, and backlog of orders jumped from 44.8 to 51.7 in the second month of the year, the highest reading since July 2023. Additionally, new orders rose 0.9 points to 52.2, a two-month high, the change in inventories increased by more than three points from 47.5 to 50.6, and prices paid rose 2.2 points to 62.6 in February, a two-month high. On the other hand, business activity slipped from 54.5 to 54.4 in February, a six-month low.

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Bottom Line: A solid rise in services activity in February offers some comfort against a growing fear of increasing weakness in the U.S. economy, with all major components including?Business Activity, Employment, New Orders, and Supplier Deliveries holding steady in expansionary territory. Furthermore, while the report indicates?businesses remain concerned regarding bad weather, a reduction in federal assistance, and tariffs, near-term uncertainty regarding implementation and scope of the latter appears to be weighing far more on business than a lingering concern of resulting sustained elevated prices.??

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Finally, yesterday, factory orders rose 1.7% in January, as expected and following a 0.6% decline the month prior. Over the past 12 months, factory orders increased 3.2%, the largest annual increase in 14 months.

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Also, this morning, the trade deficit surged 34% to a record $131.4 billion in January as companies rushed to import goods ahead of scheduled tariffs. In the details of the report, the value of imports rose 10% to $401.2 billion, a record high, while exports increased 1.2% to $269.8 billion, a two-month high.

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Additionally, this morning, nonfarm productivity rose 1.5% in the final fourth-quarter report, a two-quarter low. Meanwhile, unit labor costs increased 2.2% in the fourth quarter, a three-quarter high.

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Finally, this morning, wholesale inventories rose 0.8% in the final January print, a tenth of a percentage point more than expected and the largest monthly increase since August 2022.

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-Lindsey Piegza, Ph.D., Chief Economist