The European Central Bank left its key interest rates unchanged on Thursday, but signaled policymakers are gaining confidence on inflation returning to the 2 percent target and could lower rates in coming months.

The Governing Council, led by ECB President Christine Lagarde, left the main refinancing rate, or refi, unchanged at 4.50 percent, as expected.

The deposit facility rate was held steady a record high 4.00 percent and the lending rate was retained at 4.75 percent. Policymakers consider that the key interest rates are at levels that are making a substantial contribution to the ongoing disinflation process, the ECB said. Future decisions will ensure that its policy rates will stay sufficiently restrictive for as long as necessary, the bank added.

"If the Governing Council's updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission were to further increase its confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction," the ECB said.

Markets widely expect the central bank for the single currency bloc to lower interest rates in the June 6 policy session. Expectations have been strengthened by the easing trends in inflation data, though underlying price pressures remain high, and recent comments from ECB policymakers including Lagarde. "Even if the policy announcement does not explicitly mention June as the moment for a first rate cut, we think that today's meeting should mark the final stop before the cut," ING economist Carsten Brzeski said.

"The faster-than-expected drop in headline inflation, as well as anaemic growth, have opened the door for some rate cuts. Not a full reversal of the rate hikes since July 2022, but rather a soft loosening of a still restrictive stance."

Capital Economics economist Jack Allen-Reynolds said the ECB's decision to update its guidance suggests that an interest rate cut at the next meeting in June is very likely.

"...we think that the conditions will be in place for the Bank to bring the deposit rate down to 3 percent by the end of the year and further next year," the economist added.

The bank reiterated that it will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction, and that it is not pre-committing to a particular rate path.

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