ECB cuts interest rates by 25 basis points but warns on ‘elevated’ inflation
The European Central Bank (ECB) started the firing gun on interest rate cuts on Thursday but hopes of a steady downward rate path were dashed by cautious policymakers.
In a widely expected decision, rate-setters cut the main interest rate by 25 basis points, bringing it to 3.75 per cent. The main refinancing rate and the marginal lending facility were cut by the same amount, bringing them to 4.25 and 4.50 per cent respectively.
The ECB noted that inflation had fallen significantly since September, when it last raised rates. “Underlying inflation has also eased, reinforcing the signs that price pressures have weakened, and inflation expectations have declined at all horizons,” it said in a statement.
“It is now appropriate to moderate the degree of monetary policy restriction after nine months of holding rates steady,” the ECB added.
The decision means the ECB has stolen a march on the Bank of England and the Fed as central banks all over the world consider when to start reducing rates.
Interest rates all rose rapidly in 2022 and 2023 as central banks reacted to soaring inflation. With inflationary pressures easing, investors have turned their attention to how fast interest rates will fall
Over the past few weeks a number of smaller central banks have started cutting interest rates, including the Swiss, the Swedish and the Canadian.
The ECB was always likely to be among the earliest movers, particularly compared to the US, due to the weakness of the eurozone economy.
“The Eurozone economy is in a different place than the US, which is subject to a resurgence in inflation and a looser fiscal stance,” Yael Selfin, chief economist at KPMG said.
The big question for investors is whether the ECB’s decision marks the start of a steady reduction in interest rates around the world, or whether central banks will pause to wait for more data before moving further.
The ECB was deliberately vague about the future path of interest rates, reflecting recent data that suggests price pressures remain stubbornly high.
Figures out last week showed that prices across the eurozone rose slightly faster than expected, coming in at 2.6 per cent. The services component, which more accurately captures home-grown price pressures, jumped back over four per cent.
Wage growth meanwhile climbed back up to record levels in the first quarter of 2024, with negotiated pay settlements rising 4.7 per cent from a year ago. Most economists had expected pay growth to ease.
The ECB confirmed that it would continue to follow a “data-dependent and meeting-by-meeting approach” in the months ahead, stressing it would not pre-commit to a particular rate path.
Despite worries about inflation, Dean Turner, chief eurozone economist at UBS Global Wealth Management, said the ECB would be able to cut rates further in the months ahead.
“The timing of the next move from the ECB is uncertain…(but it) should feel confident enough to ease policy, most likely at a pace of one cut per quarter,” he said.
Alongside its rate decision, the ECB published updated economic forecasts. These showed headline inflation averaging 2.5 per cent in 2024 and 2.2 per cent in 2025, upgrades on its previous round in March.
“Domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year,” the ECB said.
Carsten Brzeski, ING’s global head of macro, said the ECB’s decision to cut rates while upgrading its inflation forecasts showed that it was more confident that its forecasts were accurate.
“The rate cut decision marks an attempt to become a real forward-looking central bank again,” he said.
The Bank of England is expected to start cutting interest rates later in the summer while the US Federal Reserve is expected to wait until at least September.