There is no question the European Central Bank will start cutting rates in June. What will happen next?
The European Central Bank is poised to cut interest rates for the first time in almost 5 years tomorrow on Thursday. The move will start bringing rates on the euro down from their all-time high of 4%, giving new life to the Eurozone economy.
Markets price in a cut tomorrow with absolute certainty, with ECB President Christine Lagarde giving several statements in that direction. The size of the cut, however, is yet uncertain but won’t likely be bigger than 0.5%.
“Judging by the commentary from officials, there is no questioning of the wisdom of cutting rates on 6 June,” said Mark Wall, ECB watcher at Deutsche Bank.
That is despite Eurozone inflation being stubbornly high, Wall continued. After a steep fall at the end of 2023, inflation in the 20 countries using the euro remained above the 2% target for several months.
May inflation in the Eurozone came in at 2.6%, higher than expected and a 0.2% jump from the previous month. Core inflation, a measure excluding volatile goods like food and energy, measured 2.9% in May.
Future moves
On top of high inflation, the Eurozone economy also saw a slight rebound after a long stagnation in 2023. GDP growth in the bloc expanded by 0.3% in the first quarter of 2023 and is expected to increase by 0.6% this year.
Last year’s crisis was mainly driven by Germany and the Netherlands, two of the EU’s largest economies, falling into recession. Both countries were major importers of Russian gas, an energy staple for their power-hungry industries. After the Russian invasion of Ukraine, gas shortages brought German and Dutch industries to their knees.
The slow economic activity likely caused inflation to slow as fast as it did. In the United States, where consumer activity and low unemployment are making the economy as strong as ever, inflation is higher than in the Eurozone. And that is despite Eurozone inflation being higher than the US’s at its peak in 2022.
Indeed, inflation in the United States is so high markets now expect only one rate cut by the Federal Reserve in 2024. The gap between interest rates in Europe and in the US will be another factor closely watched by the ECB. A widening gap would disrupt the USD/EUR rate, causing significant issues in the exchange of goods between the world’s two largest economic blocs.
For these reasons, new cuts after the June meeting are unlikely in the immediate term. The ECB, analysts believe, will likely maintain a rate of one cut per quarter as inflation slowly reaches the target.
