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Investing.com -- The European Central Bank is taking a cautious approach to rate cuts, but Bank of America (NYSE:BAC) believes the ECB will be forced to cut rates more than expected to cushion against a shallow economic recovery and inflation undershooting its target.

"We still see more cuts in 2025/26 than the markets are pricing, with a return to a deposit rate of 2% by 3Q25 (at the latest) and to 1.5% in 2026," Economists at BofA said in their latest Euro Area Viewpoint.

The economic outlook is at the heart of this dovish call, as further weakening in economic activity could likely force the ECB rate cut as early as October 2024, with cumulative cuts of 50 basis points in 2024 being a lower bound, the economists said.  

Europe's recovery remains fragile, BofA believes, and will likely be shallow, pressured by several economic factors including slowing growth in China as well as political factors.

"Sentiment is deteriorating, the labour market is no longer as firm as it was, savings rates are rising again," BofA said, adding that the negative risks from political uncertainty outweigh "the possibility of small fiscal slippage here and there."

As economic growth is expected to remain sluggish, inflation is likely undershoot the central bank's 2%, the economists noted, forecasting euro-area core inflation at 2.8%, 1.9%, and 1.8% for 2024, 2025, 2026, respectively.

While the ECB remains cautious on rate cuts, inflation undershooting the central bank's target would force the ECB to cut rates to their "neutral rate assumption in 2025 and further in 2026," BofA said, adding that this scenario remains their base case. 

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