For the first time in history, the ECB cut rates before the Federal Reserve during an inflationary cycle. What next?
The European Central Bank cut interest rates for the first time since 2019 on Thursday, bringing them down from a record-high 4%. The ECB slashed rates by 0.25% in a widely anticipated move, becoming the largest central bank to cut rates so far this cycle.
Markets had fully priced in a cut but still positively welcomed the news. The STOXX Europe 600 jumped 0.66% before the bell on Thursday.
The ECB brought interest rates to 4% last September after inflation in the Eurozone had reached double-digit growth in late 2022. Since then, inflationary pressure eased gradually, with a steep fall in late 2023.
Although Eurozone inflation remains above the 2% target, it’s still far lower than in the US, its closest economic peer. May inflation in the 20 countries using the euro came in at 2.6%, edging up slightly from the 2.4% reported in April.
For comparison, May inflation in the United States remained stubbornly high at 3.4%.
Following the rate cut, ECB President Christine Lagarde stated that inflation is on a stable path toward the target. "Our confidence in the path ahead has been increasing over the last months," she said, although global risks could edge inflation up again in the upcoming future. These risks include energy-related challenges from geopolitical crises in Ukraine and the Middle East, Lagarde said.
Future moves
After the announcement, the ECB posted a new forecast for future inflation levels. The Frankfurt staff lifted all forecasts, placing inflation at 2.5% in 2024 from 2.3%. The prediction also saw 2025 inflation jumping to 2.2% from 2% while the 2026 forecast remained stable at 1.9%.
The report showed the ECB is in no rush to cut interest rates. Markets predict one cut for each quarter until inflation finally breaks the target level.
The economic performance of the Eurozone is another factor closely watched by Frankfurt officials. After a long stagnation in 2023, Eurozone GDP increased slightly in Q1 2024 at 0.3%. Every economic indicator, including unemployment, points to a larger GDP growth in the current quarter.
Another factor to consider is the timing of interest rate cuts by the US Federal Reserve. American inflation remains stubbornly high at 3.4%, rising from 2.9% in December 2023.
Markets predict only one rate cut by the Federal Reserve this year, most likely before the elections in November. The ECB won’t increase the gap with the dollar’s interest rate too much to avoid messing with the EUR/USD exchange rate.
A return to pre-COVID interest rates will therefore be slow and cautious.
