ECB starts cutting rates even as inflation fight continues
The central bank trims its deposit rate to 3.75% from a record 4%, its first reduction since 2019
THE European Central Bank (ECB) cut borrowing costs from record highs on Thursday (Jun 6), acknowledging progress in its battle against high inflation but also signalling that the fight had yet to be won as inflation was set to remain too high until next year.
Inflation in the 20 countries that share the euro has fallen from more than 10 per cent in late 2022 to just above the ECB’s 2 per cent target in recent months, largely thanks to lower fuel costs and a normalisation in supply after some post-pandemic snags.
But that progress has stalled recently and what had looked like the start of a major ECB easing cycle only a few weeks ago now appears more uncertain due to signs that eurozone inflation may prove sticky, as has been the case in the US.
The ECB welcomed the fall in price growth as it trimmed its deposit rate to 3.75 per cent from a record 4 per cent, its first cut since 2019. It gave no indication as to whether that would be followed by a further easing in July.
“We are not pre-committing to a particular rate path,” ECB president Christine Lagarde told a press conference. “Despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year.”
Asked if the ECB was moving into a phase of “dialling back” its tight monetary policy stance, Lagarde said that she could not confirm such a process was underway, but that there was “a strong likelihood”. She added: “But it will be data-dependent, and what is very uncertain is the speed at which we travel and the time that it will take.”
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The ECB also raised its inflation forecasts for this year and the next, stressed any further rate reduction would depend on incoming data and reaffirmed that borrowing costs needed to remain high enough to keep a lid on prices.
“Despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year,” it said.
Money market investors trimmed their bets on rate cuts after the announcement and only priced in one, with a slight risk of a second, for the remainder of the year.
With Thursday’s move the ECB joins the central banks of Canada, Sweden and Switzerland in undoing some of the steepest streaks of interest rate hikes in recent history. The US Federal Reserve, stopped in its tracks by some stronger-than-expected inflation readings earlier this year, is widely expected to join in after the summer.
But some stronger-than-expected data about eurozone inflation, wages and economic activity over the last few weeks has fuelled fears of a more difficult “last mile” on the way to the ECB’s goal.
Inflation in services, which some policymakers have singled out as especially relevant because they reflect domestic demand, has been a particular concern after it rebounded to 4.1 per cent in May from 3.7 per cent a month earlier.
Most economists still expect the ECB to continue cutting its policy rate in the coming months and bring it to 2.50 per cent by the end of 2025. But they see just two more reductions this year, in September and December.
“Further cuts in September and December remain our central case,” HSBC economist Fabio Balboni said in a note. “But if the recent resilience in services inflation proves sustained, we see increasing chances that the ECB might have to be more cautious on the way down.”
A rebound in growth also reduced the urgency for the ECB by undermining the argument that high rates are choking economic activity. The real elephant in the room may be the Fed, however, and whether it starts or further delays its own easing cycle. A more restrictive Fed would likely mean a weaker euro and higher imported inflation for the currency bloc, but it would also increase yields on global bond markets – a double whammy whose net effect is hard to predict.
“The pace of rate cuts will be dependent on the US and the Fed,” Mohit Kumar, an economist at Jefferies said. “In the event that the Fed doesn’t cut rates at all this year – not our base case – we could see only two cuts from the ECB this year.”
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