The ECB cut interest rates in line with market expectations

This article was originally published on English language

The ECB cut the main refinancing rate to 4.25%, the marginal lending rate to 4.50% and the deposit rate to 3.75%, which has been widely signaled by its policymakers in recent weeks.

This is the first decrease since March 2016 in both the main rate for refinancing operations and the marginal lending rate, and for the deposit rate it is the first decrease since September 2019.

Why did the ECB cut interest rates?

Frankfurt’s overall rate hike of 450 basis points between July 2022 and September 2023 helped reduce core eurozone inflation from a peak of 10.6 percent in October 2022 to 2.6 percent in May 2023.

In March, ECB President Christine Lagarde said that there would be more clarity and sufficient information by June. It seems that moment has arrived.

Although inflation has not yet fully reached the 2% target, its substantial decline signals a downward trend that is expected to continue in the coming months.

According to the latest ECB forecasts from March 2024, the average inflation rate will decrease to 2% in 2025 and to 1.9% in 2026. As for core inflation, which excludes energy and food prices, it will be 2.1 percent in 2025 and 2.0 percent in 2026.

A rate cut of 25 basis points will also help keep real interest rates positive, as nominal rates will remain above the current rate of inflation. Therefore, this indicates a reduction in the degree of restrictiveness of monetary policy rather than a broader normalization.

Rising and rising borrowing costs have slowed economic growth in the bloc, curbing demand and dampening price pressures.

In the first quarter of 2024, the eurozone economy grew by 0.3%, while the previous two quarters were marked by a contraction of 0.1%. In the second quarter of 2023, there was a slight increase of 0.1%, and in the first quarter of 2023 and the last quarter of 2022 – stagnation.

Will the ECB continue to cut rates after June?

The latest statements by ECB officials indicate that there will be no prior commitment to further rate cuts after June.

This means that a further rate cut in July remains uncertain as the ECB seeks to maintain flexibility in its decisions and continues to monitor economic data.

Eurozone inflation rose to 2.6% in May, above expectations of 2.5%, and core inflation rose to 2.9% from 2.7% in April.

We expect President Lagarde to reiterate that more information will be available in July to make the next decision, with even more clarity expected by September.

The new June economic forecasts may suggest a slight upward adjustment to economic growth and inflation for 2024, while keeping the 2 percent inflation forecast for 2025 unchanged.

What are the risks of too much or too little rate cuts?

The ECB is faced with the task of balancing the risks of too strong and too weak rate cuts.

If Frankfurt eases monetary policy too quickly and significantly, this is likely to boost consumer demand and investment. However, it could also lead to renewed inflationary pressures before the 2% target is fully achieved.

The ECB will expose itself to the risk of uncertainty related to energy prices and geopolitical tensions, while reducing buffer capacity, which could potentially lead to undesirable consequences for price dynamics.

In addition, although President Christine Lagarde emphasized that the ECB “depends on the data, not on the Fed”, the divergence between the policies of the world’s two largest central banks could have significant financial consequences, especially for exchange rates.

Aggressive rate cuts by the ECB while maintaining higher interest rates by the Fed will put strong downward pressure on the euro against the dollar, which is accompanied by further increases in the prices of imported goods and services.

Conversely, if Frankfurt sticks to tight monetary policy for too long and cuts rates less than the market expects, it risks slowing economic growth in the eurozone and widening the gap with the United States.