In a wide-ranging policy decision, the European Central Bank (ECB) today announced a 0.25 percentage point cut in key interest rates, citing falling inflation. However, “domestic price pressures remain strong, with wage growth high, and inflation expected to remain above target well into next year,” reads the introductory statement.
ECB President Christine Lagarde gave no notes on the future trajectory of rate cuts, echoing earlier statements that the ECB Governing Council will follow a data-dependent approach and meet at case by case.
“Based on an updated assessment of the inflation outlook, underlying inflation dynamics and the strength of monetary policy transmission, it is now appropriate to moderate the degree of policy tightness monetary policy after nine months of maintaining rates,” we can read in the introductory note.
This is the first interest rate cut in eight years and follows ten rate hikes since the Frankfurt-based institution began its rate hike cycle in July 2022.
Markets currently assess the probability of a further ECB rate cut at the July 18 meeting at 12% and the probability of a cut in September at 63.4%. Whether there will be a third decline in 2024 is hotly debated and markets are only pricing in two declines.
“The last thing the ECB would want to do is have to raise its ratings if next month’s inflation figures soar again. So the remedy is not to make hasty decisions,” said Michael Field, strategist for European markets at Morningstar. “We have come a long way from the highs of 10.6% inflation seen only 18 months ago, and at this stage lower interest rates seem appropriate. »
The reactions of the stock, bond and currency markets were muted, as this decision had been widely anticipated.
The interest rate of the main refinancing operations and the interest rates of the marginal lending facility and the deposit facility will be revised downwards by 0.25 percentage points each, to 4.25%, 4. 50% and 3.75% respectively, effective June 12, according to the note.
The ECB revises its inflation forecasts upwards
The latest Eurosystem staff projections for headline and core inflation have been revised upwards for 2024 and 2025 compared to the March projections. Experts now forecast average overall inflation of 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026. As for inflation excluding energy and food, experts forecast an average of 2.8% in 2024, 2.2% in 2025 and 2.0% in 2026. Economic growth is expected to accelerate to 0.9% in 2024, 1.4% in 2025 and 1.6% in 2026 .
The ECB anticipates the Fed’s decision
The ECB Governing Council made history: for the first time, the European bank outstripped its American counterpart in setting interest rates. But the decline followed similar measures taken by other major Western central banks. The Swiss National Bank (SNB) was the first major bank to announce a rate cut in March, followed by Swedish bank Riskbank in May. Yesterday, the Bank of Canada announced it would cut its overnight interest rate to 4.75%, after six consecutive pauses.
The US Federal Reserve (Fed) and the Bank of England (BoE) will announce their monetary policy decision on June 12 and 20 respectively. In the United States, the rate cut is delayed because of the inflation surprise in the first quarter, says Preston Caldwell, Morningstar U.S. economist. “Our federal funds rate forecast for the end of 2024 increases to 4.75%-5.00%, up from 4.25%-4.50% previously. »
How big will the fall in European interest rates be?
Most analysts agree that the ECB will keep its ratings unchanged at its July 18 meeting, but will resume cuts at a slow pace of 0.25 percentage points at its September 12 meeting.
“If the ECB had not announced the rate cut so strongly this week, we believe there would have been a lively debate over whether to wait for further data after the recent figures. “It is very likely that Lagarde will guide markets towards holding in July, with the next adjustment in September or October,” said Dave Chappell, Senior Fund Manager. Fixed Income at Columbia Threadneedle Investments, in a note ahead of today’s ECB decision.
Karsten Junius, chief economist at J. Safra Sarasin Sustainable, agrees that a September rate cut is the most likely scenario. “We believe that monetary policy has been too restrictive for too long. We therefore expect further rate cuts in September, October and December, towards a level of 3.0% at the end of the year.” , markets are currently pricing in a level of 3.3% for December,” he said in a note ahead of today’s meeting.
“In our view, financial markets do not expect sufficient rate cuts this year. The Eurozone clearly differs from the United States and we expect the ECB to act independently of the Federal Reserve and based on its national needs.
Kathleen Brooks, research director at XTB, expects two more declines this year. “The market is currently noting the prospect of two further rate cuts this year, and Eurozone rates are expected to end 2024 at 3.25%, compared to 4.84% for the United States,” he said. -she declared.
How will interest rate cuts affect markets?
Stock markets tend to rise on expectations of rate cuts, while bond markets tend to suffer. On the other hand, with interest rates already high, lower rates also mean lower bond yields, which pushes bond prices higher. Lower ratings also make existing bonds, and particularly those already issued during a period of high rates, more attractive in terms of yield.
In the meantime, bank account savings rates will likely decline, to the detriment of savers. Borrowers, on the other hand, are expected to benefit from falling rates as consumer debt and mortgages become cheaper. In its latest economic bulletin, the ECB indicates that business loan rates have already fallen slightly, reaching 5.2% at the end of 2023, while mortgage rates have increased further to 4.0%.
