Summary
- The European Central Bank (ECB) today joined the growing group of advanced economy central banks that have begun their monetary easing cycles, lowering its Deposit Rate by 25 bps to 3.75%.
- ECB policymakers cited the past drop of inflation and the improving inflation outlook as key factors behind their decision to lower interest rates. There were some elements of caution, however, as the ECB said domestic price pressures remain strong as wage growth is elevated, and revised up its near-term inflation forecasts.
- We view the ECB’s statement as consistent with further rate cuts, albeit at a measured pace. The ECB said it will continue to follow a “data-dependent and meeting-by-meeting approach” in determining its interest rate decisions.
- Over the rest of 2024, our base case is for the ECB to pause in July before cutting rates again in September, October and December. However, we suspect ECB policymakers would prefer to see a return to an overall downward trend in wage growth and domestic inflation to be fully comfortable in lowering interest rates further, and thus view the risks as tilted toward lesser easing.
European Central Bank Kicks Off Its Rate Cut Cycle
The European Central Bank (ECB) today joined the growing group of advanced economy central banks (including the Swiss National Bank, Riksbank and Bank of Canada) that have begun their respective monetary policy easing cycles. The ECB lowered its benchmark interest rates by 25 bps, bringing its Deposit Rate to 3.75%, and offered several perspectives in support of its decision to ease monetary policy, saying:
- Inflation has fallen more than 2.5 percentage points since September 2023 (when the policy rate reached its peak), and the inflation outlook has improved markedly.
- Underlying inflation has also eased, and inflation expectations have declined at all horizons.
- Monetary policy has kept financing conditions restrictive. By dampening demand and keeping inflation expectations well anchored, this has made a major contribution to bringing inflation back down.
While clearly acknowledging the improving inflation situation, the ECB’s announcement was balanced by some cautious and hawkish elements, saying domestic price pressures remain strong as wage growth is elevated, and that inflation is likely to stay above target well into next year. Indeed, near-term core inflation projections (CPI excluding food and energy) have been revised higher to 2.8% for 2024 (previously 2.6%) and to 2.2% for 2025 (previously 2.1%). The core inflation forecast for 2026 was unchanged at 2.0%. The ECB also raised its GDP growth forecast for 2024 to 0.9%, from 0.6% previously.
In terms of policy guidance, we view the ECB’s statement as consistent with further rate cuts, albeit at a measured pace. The ECB said it will “keep policy rates sufficiently restrictive for as long as necessary to achieve” a timely return to the 2% inflation target. Use of “sufficiently” restrictive does, in our view, allow for some further reduction in interest rates given their currently elevated levels. The ECB added however that it “will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction.” Finally, the ECB said it is not committing to a particular rate path.
Today’s interest rate reduction was clearly signaled ahead of time by ECB policymakers and widely forecast, including by ourselves. Going forward, we have also forecast the ECB will hold rates steady in July before delivering another 25 bps rate cut in September. By the fourth quarter we expect Eurozone wage growth and underlying inflation may have slowed sufficiently for the ECB to deliver rate cuts at its October and December meetings, especially if the Federal Reserve begins lowering interest rates as well. If realized, that would see the Deposit rate lowered by a cumulative 100 bps this year to end 2024 at 3.00%.
We view today’s announcement as very much consistent with the ECB keeping interest rates unchanged at its July meeting, while the optionality embodied in today’s statement would allow for a resumption of rate cuts in September. That said, we view the risks around our ECB easing outlook for this year as tilted toward a lesser 75 bps of rate cuts, compared to our base case for a cumulative 100 bps of rate reduction. ECB policymakers are likely wary of the modest uptick in Eurozone wage growth reported for Q1, and the uptick of core inflation and particularly services inflation in May. Over the next few months ahead of the ECB’s 12 September monetary policy announcement we will get CPI inflation data for June, July and August, and both the Q2 Indicator of Negotiated Wages along with Q2 compensation per employee (the most comprehensive wage measure) will be available in time for the September meeting. We suspect ECB policymakers would prefer to see a return to an overall downward trend in wage growth and domestic inflation to be fully comfortable in lowering interest rates further. Against that backdrop, a further interruption to the disinflation progress could put one of our expected September or October rate cuts at risk.
