The European Central Bank (ECB) has reduced interest rates to 2.5% from 2.75% in an effort to stimulate growth in response to ongoing economic challenges. This marks the sixth rate cut in seven meetings, further widening the gap between European borrowing costs and those of the U.S. As Europe’s economy continues to struggle, the ECB is taking action to counteract the dual pressures it faces—one from the threat of tariffs from the U.S. and another from a sudden need to increase military spending.

The decision comes as Germany announced plans to invest up to €1 trillion (around $1.1 trillion) in defense and infrastructure. Although this plan has not been finalized, it has already shifted the economic outlook for Europe, sending shockwaves through global financial markets. Investors responded with a sell-off in European government bonds, betting that increased government spending could lead to higher inflation and stronger economic growth. The euro strengthened as a result, rising to $1.08 from below $1.04 over the past week. The shift in expectations has caused some analysts to revise their projections for the ECB’s future rate cuts, with some now predicting a reduction of 0.7 percentage points by December, down slightly from earlier forecasts.

The German spending package, if enacted, is expected to provide long-term support for economic growth and potentially push inflation higher. However, Europe’s export-driven economy remains highly vulnerable to tariffs, especially with the U.S. being the continent’s largest export market. While tariff impacts on inflation remain uncertain, there are concerns that a trade war with the U.S. could slow economic growth. Recent data suggests the eurozone economy is growing only sluggishly, with inflation moving closer to the ECB’s target of 2%. However, underlying inflation remains relatively sticky at 2.6% in February, which could continue to encourage the ECB to pursue additional rate cuts.

Given the uncertainty surrounding trade tensions and the delayed effect of Germany’s proposed fiscal stimulus, analysts expect the ECB to continue cutting rates, possibly bringing them down to around 2% by the summer. However, the massive military and infrastructure spending plans by Germany, as well as other potential fiscal measures by European governments, could lead the ECB to pause its rate cuts. ECB President Christine Lagarde has indicated that future policy decisions will be made based on the most current economic data, which will be reviewed at each meeting to assess the ongoing challenges and opportunities facing Europe’s economy.