The ECB’s decision to lower its key rates for the first time since 2019 marks a new chapter. With an inflation rate of 2% in the viewfinder. How can this reduction impact the daily economy?
The ECB has decided: by lowering its key rates for the first time in five years (!), the institution is taking a clear turn, even if awaited for months. The decrease is minimal (-25 basis points), but it already says a lot about the current trend. With, in sight, the objective of finding inflation at 2% in 2025. How to explain this decision, and who can it benefit (or not)?
1. The ECB lowers its rates: good decision?
Unsurprisingly, the ECB’s decision to lower its rates to 3.75% did not create a stir. It was more than announced and had no major impact on the financial markets, which had already integrated it into their models. “The ECB made the right decision,” judges economist Eric Dor (IÉSEG School). In the euro zone, inflation is trending downward. A scenario of convergence towards 2% is emerging. On the other hand, geopolitical shocks or surprises on wages can always lead the Central Bank to review its position.”
For Bernard Delbecque, specialist in monetary policy (UCLouvain) and director of research at EFAMA, controlling inflation remains uncertain. “The question is whether inflation will continue to fall to reach the 2% objective. This being said, it is necessary to take into account potentially negative effects of high interest rates on growth.”
2. The impact on the real estate market
The first beneficiary of this slight drop in key rates is undoubtedly the real estate market. The decision could allow future buyers to take out credit at more affordable rates, even if the mere drop of 0.25% is not extraordinary. “Monetary policy being gradual by tradition, this trend will continue in the coming months, but we do not know at what rate», predicts Bernard Delbecque.
“It is for the real estate market that the reduction in rates is best received.”
Eric Dor
Economist (IÉSEG School)
A turning point has therefore clearly been taken, even if some observers fear a situation where a rebound in inflation would push the Central Bank to reverse its decision. For the economist, this hypothesis is however unlikely. “We had to start gradually lowering interest rates in view of the good work that has been done on inflation. This gives a little oxygen to the real estate sector.”
Eric Dor agrees. “It is for the real estate market that the reduction in rates is best received. High rates harm the interests of young households who want to access property. The latter also suffered a double punishment: they have both inherited prices inflated by years of low rates, and then much higher monthly loan payments.”
3. The impact on savings
Unlike the real estate market, savings could suffer the consequences of this ECB decision. Extremely reluctant to increase their interest rates, private banks should not miss the opportunity to follow the downward trend. “It’s a possibility, although it don’t expect radical changes. We took a turn, but not at a right angle,” illustrates Bernard Delbecque.
For Eric Dor, there is little doubt that the banks will graft their policy onto this decision. “We should no longer have many illusions about an improvement in the rate of savings deposits. The outbidding of banks to attract state bond money, via cash vouchers or term accounts, is above all temporary hits on specific products. Structurally, the situation does not change.”
4. The euro depreciated against the dollar after the ECB rate cut?
The ECB is the first central bank to lower its rates. The Fed and the Bank of England have yet to follow suit. “We don’t know if this is a sign of courage, but the ECB is in any case showing a direction. In the short term, the European institution could afford it, without necessarily having to model itself on the United States. However, elements of coordination between central banks could intervene to avoid effects on exchange rates”believes Bernard Delbecque.
For Eric Dor, the fact that the ECB is the first central bank to move in this direction risks causing the euro to depreciate against the dollar. “In other words, it increases the price in euros of everything we buy in dollars. But since two-thirds of eurozone countries’ trade is internal, the effects should be controllable. The ECB does not fear them in any case.”
5. The impact on growth
The euro zone has long suffered from a growth deficit. Monetary policy can help raise the bar. But, in the current context, other factors strongly influence the economic situation: the war in Ukraine, the elections in the USA, or the European elections, to name a few. “We should therefore not think that this decision will fundamentally change the situation. It’s a first step that can make a mark the ECB’s desire to minimize the negative effects of high interest rates on growth. But it’s more of an art than an exact science,” notes Bernard Delbecque.
This is a first step which can mark the ECB’s desire to minimize the negative effects of high interest rates on growth. But it is more of an art than an exact science.
Bernard Delbecque
Economist (UCLouvain)
Furthermore, the future debate will also be to determine whether the requirement is still to cap inflation at 2%. “One may wonder whether this objective remains relevant today given demographic developments and tensions on the labor market. Should we accept that the average inflation rate is closer to 3%?,” asks the UCLouvain professor.
6. Further declines in September and December?
The ECB is unlikely to cut rates again in July or August. For economist Eric Dor, banking on a further reduction of 0.25% in september then in December is possible. The key rate would then show 3.25%. “The ECB is clear: we will no longer return to 0 rates. After ten successive increases between July 2022 and July 2023 (Editor’s note: +4.5% in total), we should return to a so-called ‘neutral’ rate, namely between 2 and 2.5% by 2025.”
