European Central Bank set to cut interest rates despite inflation worries
The European Central Bank is all but certain to be the first major central bank to cut interest rates this week as it shrugs off a rise in inflation and takes a different path in monetary policy from the UK and US.
Markets, economists and ECB officials alike are highly confident that the central bank will lower its benchmark deposit rate by 25 basis points from a record high of four per cent at its next meeting on Thursday.
However, economists have questioned why the ECB, which has promised to take a data-dependent approach, is so keen to cut interest rates after data last week showed inflation in the eurozone rose in May.
Consumer prices in the 20 countries that share the euro rose by 2.6 per cent in May from a year earlier, according to Eurostat’s flash estimate, up from 2.4 per cent in April and edging further away from the ECB’s target of two per cent.
The data marked the first rise this year and came in slightly hotter than economists’ expectations of 2.5 per cent, partly driven by the first positive energy price growth reading in more than a year.
JPMorgan economist Greg Fuzesi told the Financial Times that the ECB’s expected cut would be “somewhat rushed and odd” and that “the cost of waiting until September appears low while the benefit of getting more clarity on the inflation outlook appears high”.
However, dovish ECB rate-setters have sought to downplay the inflation reading, with Portuguese central bank governor Mário Centeno arguing it was “not a significant deviation” from expectations and Italian central bank head Fabio Panetta calling it “neither good nor bad”.
Still, economists believe the inflation reading is likely to convince policymakers to be less aggressive in rate cuts after June. Markets are currently betting that the ECB will make just one additional cut in 2024, with a small chance of a third.
The ECB’s approach is risky as it differs starkly from its two international peers – the Bank of England and the US Federal Reserve, which is considered a trend-setter in Western monetary policy.
The Bank of England is widely expected to cut rates in either August or September, with predictions pushed back following hotter-than-expected inflation figures for April last month.
Hawkish comments from rate-setters in the US have convinced economists that the central bank will not start lowering borrowing costs until September at the earliest. Markets currently expect two cuts this year, down from the six anticipated at the start of 2024.
Minutes from the Fed’s most recent meeting last month showed an unspecified number of policymakers were even open to raising rates if inflation worsens.
ECB president Christine Lagarde and other policymakers have said they are ready to take a different path from the Fed, even if it opens the door to a weaker euro that could stoke inflation.