The European Central Bank cut interest rates, for the first in nearly five years. However, future cuts will depend on whether or not price pressures continue to ease.
The quarter-point reduction to 3.75 percent on Thursday, which was not replicated yet by the central banks of the US or UK, marked a significant milestone in the battle against inflation following the largest price surge for a decade.
Christine Lagarde, president of the ECB, said that there was a’strong likelihood’ the decision would mark the beginning of ratings being “dialed back” from their highest point. She added that further actions would depend on “the data we receive”.
Several members said after the decision on Thursday that another rate reduction at the next meeting of July was unlikely due to recent increases in inflation and wage growth.
After the announcement traders on swaps markets reduced their bets for a second reduction by September from 70% to 60%.
The ECB warned that it “was not pre-committing” to a specific rate path and warned that it expected inflation would remain above its 2 percent target until the last quarter of 2025.
Katharine Nesse, a former Bank of England economics who now works at investor PGIM fixed income, said: “It appears that they have given themselves a little more wiggle-room for further caution in case data does not continue to come out as benignly as they expect.”
The bank said that it would cut rates as a result of a drop in inflation in the Eurozone by more than 2,5 percentage points since September 2023, when its last rate hike was made.
One council member said, “It was widely agreed that we were on track to achieve our inflation target. And confidence in our forecasts is growing that will allow us to continue to lower rates.”
Lagarde stated that the ECB decided to reduce “because our overall confidence in the future path. . . The reliability of our forecasts has increased significantly in the last few quarters.
The ECB raised its inflation predictions for the year ahead. It said that it would average 2,5% in 2024, 2,2% in 2025, and 1,9% in 2026.
Robert Holzmann, a hawkish Austrian central banker, was against the rate cut.
Holzmann said after the meeting that “data-based decision should be data-based”.
Holzmann’s argument was rejected by another ECB rate-setter, who said that the rise in inflation and wage increases in the Eurozone in recent months made a reduction in interest rates incompatible.
Lagarde predicted wage growth would slow, and worker productivity would increase over the course of the year. This would help ease pressure on labour costs for companies.
Dirk Schumacher is a former ECB economics now working at the French bank Natixis. He said: “I believe that their baseline should be further cuts.” But wage growth must be moderated for this.”
Last week, data released showed that Eurozone inflation increased for the first time in this year, to 2.6% in May. This was driven by an increase in the labor-intensive service sector. It had slowed down from a high of over 10% in 2022.
In the first quarter, wage growth was close to reaching a record of 4.7%.
After Lagarde’s speech, the euro rose by 0.1 percent to $1.0874.
The yields on two-year German Bunds, which are sensitive to interest rates and serve as a benchmark in the Eurozone, increased by 0.05 percentage points.
The move on Thursday came one day after the Bank of Canada made a similar cut. It follows other central bank decisions this year to ease their monetary policies in Brazil, Mexico Chile, Switzerland, and Sweden.
The US Federal Reserve, on the other hand, is expected to hold rates at a high of 5,25 to 5.5 percent next week. This range has been in place for 23 years. It was decided that the price pressures within the largest economy in the world were more persistent than expected.
When it meets on 20th June, the Bank of England will also be unlikely to reduce its bank rate below a record high of 5,25 percent.
The ECB raised its growth forecast from 0.6 to 0.9 percent for this year. The ECB expects growth of 1.4 percent next year, and 1.6 percent in 2026.
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