European Central Bank reduces interest rates again

The European Central Bank has cut interest rates a second year in a row amid growing concerns over a possible recession in the Eurozone.

The 20 central banks that use the Euro lowered their main deposit rate on Thursday by a quarter-point to 3.5% from 3.75. This move was widely anticipated and follows the ECB’s rate cuts in June.

Following the announcement, the euro was broadly unchanged against the pound at €1.31 and the dollar at $1.101. The Stoxx 600 pan-European index rose by 5.75 points or 1.13 percent to 513.78.

The ECB stated that it will “continue to use a meeting-by-meeting and data-dependent approach in determining the appropriate levels and durations of restrictions”. In a press release, its governing council stated that it “was not pre-committing to any particular rate path”.

Christine Lagarde and the governing Council of the ECB have ratcheted up interest rates to a record of 4% in Europe since July 2022 in order to combat a spike in inflation that reached a high of almost 11%.

Lagarde (68) said that inflation is developing as forecasted, but that the outlook for growth is worrying. She said that future interest rates cuts are “pretty evident”, but refused to say when they would happen.

“Domestic inflation is high because wages continue to rise at a rapid pace.” She said that labour costs are easing and profits are helping to partially offset the impact of rising wages on inflation.

The Russian invasion of Ukraine has shook European energy markets, reducing gas supplies and causing inflation to rise in 2022-2023. Germany, Europe’s biggest economy, relied for decades on cheap Russian natural gas to power its manufacturing and industrial output. Since then, inflation has dropped to 2.2%.

The ECB has revised its projections for the eurozone’s economy downward. It now expects it to grow by 0.8 percent this year, 1.3 percent in 2025, and 1.5 percent in 2026. This is a small reduction from their June projections. The central bank predicts that inflation will average 2.5% this year, and then “should decline towards our goal over the second half next year”,

In lowering interest rates, the ECB beat the Bank of England as well as the US Federal Reserve. This is due to the slower growth in Europe compared to the UK and the US. The ECB was the first major central bank to reverse policy in June.

Analysts doubt that the ECB, at its next meeting scheduled for October 17, will reduce borrowing costs once again. Carsten Brzeski of ING, a Dutch bank, stated: “The next rate reduction looks likely in December.”

Yael selfin, chief economics at KPMG, stated that if the growth deteriorated, “it would strengthen the case for more doveish policies to increase the rate of cuts in 2020 towards a final rate of 2.25 percent”.

Mario Draghi, former ECB President and Italian Prime Minister, had warned in a 300 page report that the European Union needed to create a new Industrial Strategy, which included boosting investments by €800 billion per year to increase productivity and growth.

Lagarde largely endorsed former ECB President’s recommendations. She called it a “formidable” report.

Federal Reserve will begin to cut rates next Wednesday. The policy will be loosened by a quarter point. According to market expectations, the federal funds rate will likely fall by one percentage point from a range between 5.25 and 5.5 percent this year.

Bank of England is expected to keep the UK base interest rate at 5% at its next meeting on Thursday. Andrew Bailey, Bank of England’s governor and four members of the rate-setting panel, secured a 5-4 vote majority to reduce the base rate by one quarter point at its previous meeting.

The central bankers are really fond of numbers. They rely more on numbers to make decisions about interest rates than on their convictions about the strength or weakness of their economies (Jack Barnett).

Christine Lagarde is the president of the European Central Bank. She has been very clear that any future announcements of interest rates will be based upon this love of numbers. She is “data-dependent”.

Andrew Bailey, the chief of the Bank of England, and Jerome Powell of the US Federal Reserve have both repeated this phrase many times.

As inflation approaches the 2 percent target, the monetary policymakers tend to follow this strategy.

It seems reasonable. The rationale seems reasonable.

It is pretty “obvious” that interest rates will fall further, Lagarde said in the post-interest-rate-announcement press conference on Thursday. The pace of the decline will be determined by the economic data that is released.

Inflation isn’t the only thing a central banker needs to consider. Growth is a factor that determines the optimal interest rate level in an economy. This is the indicator that shows the greatest divergence between the economies of rich countries.

The ECB has a strong case to make for a larger or more rapid rate cut in the coming year. Since about a month, the eurozone’s economy has been in a state of stagnation.

Since the beginning of the year, the UK has experienced a stronger growth than expected. Investors are pricing in only one rate cut this year by the Bank of England.

Base case for the US calls for a soft land, but traders worry so much about the labour markets that they think the Fed will cut rates by four quarter points this year.

Economic data can confirm assumptions, but they can also change them. As the numbers come in, expect interest rates to fluctuate for the remainder of the year.