ECB Implements Rate Cut, Following Global Trend
The European Central Bank (ECB) made a significant move on June 6 by implementing its first rate reduction since 2019. Despite mixed data, the ECB lowered three key interest rates by 25 basis points from June 12. This decision decreases the rate on refinancing operations to 4.25 percent, while rates on the marginal lending facility and deposit facility were cut to 4.5 percent and 3.75 percent, respectively.
Christine Lagarde, the president of the ECB, stated that this rate cut was appropriate based on an updated assessment of inflation outlook and the strength of monetary policy transmission. Lagarde also noted that inflation had decreased sufficiently to allow for the reduction in rates. It is important to mention that this rate cut aligns with recent monetary policy easing by central banks in countries such as Canada, Brazil, Mexico, Chile, Switzerland, and Sweden.
The ECB’s Move Ahead of Other Major Economies
With this rate cut, the European Union has become the second major global economy to reduce its lending rate this week, following Canada’s decision on June 5. The ECB’s action also gives it a head start over the Bank of England and the U.S. Federal Reserve, both of which are likely still months away from making similar cuts.
Emphasis on Inflation Control
Lagarde highlighted the weakening of price pressures and declining inflation expectations as reasons for the rate cut. However, she refrained from specifying the speed or magnitude of future rate cuts, as eurozone inflation is expected to stay above the ECB’s 2 percent target into the next year. The ECB remains committed to keeping policy rates sufficiently restrictive to achieve its targeted level of inflation.
Revised Inflation Forecasts and Economic Growth
The ECB has increased its inflation forecasts for this year and next and emphasized that further rate cuts would depend on upcoming data. The bank expects headline inflation to average 2.5 percent in 2024, 2.2 percent in 2025, and 1.9 percent in 2026. In addition, inflation excluding energy and food is predicted to average 2.8 percent in 2024, 2.2 percent in 2025, and 2 percent in 2026. The ECB also projects that economic growth in the region could accelerate to 0.9 percent in 2024, 1.4 percent in 2025, and 1.6 percent in 2026.
Will the U.S. Federal Reserve Follow Suit?
The ECB’s more accommodating stance compared to the U.S. Federal Reserve has raised anticipation for a similar action from the Fed in its upcoming policy-making meeting of the Federal Open Market Committee. While a widening interest rate differential between the two regions may theoretically cause the euro to lose value against the dollar, making European exports more competitive, it would also cause government bond yields to grow in the eurozone.
However, the Fed faces a different economic situation. Government stimulus, pandemic recovery spending, and stronger growth are driving inflation in the United States. With an annual rate of 3.4 percent, the U.S. consumer price index is well above the Federal Reserve’s target rate of 2 percent.
Market indicators suggest that the Fed may proceed with its own schedule, as the euro saw an uptick and sovereign bond yields in the eurozone rose. Nevertheless, according to CME FedWatch, the markets are currently pricing a zero percent likelihood of the Fed lowering its rates this month.
In conclusion, the ECB’s rate cut follows a global trend of central banks adopting more accommodative policies. While the ECB takes action to control inflation and stimulate economic growth, it remains to be seen if the U.S. Federal Reserve will follow suit given the different economic conditions it faces.
