The European Central Bank cuts interest rates in line with market expectations

This article was originally published in English

He ECB reduced his main type of refinancing 4.25%the marginal credit rate at 4.50% and the deposit rate at 3.75%, as its political leaders had widely noted in recent weeks.

This represents the first cut since March 2016 for both the main rate of refinancing operations and the marginal credit rate, while, for the deposit typeis the first reduction since September 2019.

Why has the ECB cut interest rates?

The overall increase of 4.5 points applied by Frankfurt between July 2022 and September 2023 has contributed to reduce the general inflation rate of the euro zone from a maximum of 10.6% in October 2022 to 2.6% in May 2024.

President Christine Lagarde indicated in March that there would be more clarity and sufficient data in June. It seems that that moment has arrived. Although the inflation has not yet fully reached the 2% target, its substantial decrease points out a downward trend which is expected to persist in the coming months.

According to the ECB’s latest projections from March 2024, the average inflation rate is expected to decline to 2% in 2025 and to 1.9% in 2026. Regarding core inflation, which excludes energy and food prices, projections place it at 2.1% for 2025 and 2.0% for 2026.

The 0.25 point cut will also continue to maintain positive real interest rates, since nominal rates will remain above the current inflation rate. Thus, it indicates a reduction in the degree of tightening of monetary policy, rather than a broader normalization.

The rise in prices and the rise in the cost of loans have caused a slowdown in economic growth of the block, containing demand to curb price pressures.

Although the euro zone economygrew by 0.3% in the first quarter of 2024the two previous quarters were characterized by contractions of 0.1%. The second quarter of 2023 recorded slight growth of 0.1%, and the first quarter of 2023 and the last quarter of 2022, stagnation.

Will the ECB continue to lower rates after June?

Recent statements from ECB officials suggest that there will be no prior commitment to further cuts afterwards. This means that a new cut of rates in July remains uncertainsince the ECB intends to maintain flexibility in its decisions and continue to monitor economic data.

The eurozone inflation rose in May to 2.6%, above the 2.5% forecast, while core inflation rose to 2.9% from 2.7% in April. We hope that President Lagarde will point out once again that rmation will be available in July to guide the next decision, and it is expected even more clarity for September.

New June economic projections could suggest a slight upward adjustment of the economic growth and the inflation for 2024keeping the inflation forecast of 2% for 2025 unchanged.

What are the risks of over- or under-cutting rates?

The ECB faces the challenge of balancing the risks of excessive cutting of rates with those of an insufficient cut. If Frankfurt eases monetary policy too quickly and significantly, it would likely boost consumer demand and investment. However, it would also run the risk of reigniting inflationary pressures before fully achieving the 2% target.

The ECB would be exposed to uncertainties related to energy prices and geopolitical tensions with reduced buffers, which could have unwanted effects on price dynamics.

Furthermore, although President Christine Lagarde stressed that the ECB “It depends on the data and not on the Fed“, the divergence between policies of the two main central banks in the world could have significant financial implicationsespecially in exchange rates.

A aggressive trimming of the types by the ECB While the Fed maintains higher interest rates for a longer time I would exercise a strong downward pressure on the euro against the dollarwith the risk of greater upward pressure on the prices of imported goods and services.

On the contrary, if Frankfurt maintains a restrictive monetary policyfor too much time and cuts rates less than the market currently expects, it risks stifle economic growth of the euro zone and widen the gap with the United States.