The European Central Bank on Thursday cut interest rates for the third time this year, saying inflation in the euro zone was becoming increasingly subdued and the economic outlook worsened.
The first consecutive interest rate cuts in 13 years signal the eurozone central bank's focus has shifted from curbing inflation to protecting economic growth, which has lagged far behind the United States for the second year in a row.
“Further information on inflation indicates that the process of deflation is well underway,” the ECB said. “The outlook for inflation is also influenced by downward expectations for recent indicators of economic activity.”
The latest economic data has likely tipped the balance within the ECB in favor of rate cuts, with business activity, sentiment surveys and September inflation all coming in slightly below expectations.
The quarter-point cut will reduce the interest rate the ECB pays on bank deposits to 3.25%. The money market has almost completely priced in three additional interest rate cuts by March next year.
The ECB made no mention of future moves in its statement, instead reiterating its claim that decisions will be made “on a meeting-by-meeting basis” based on incoming data.
“The Governing Council will keep policy interest rates sufficiently restrictive for as long as necessary,” the ECB said.
Many ECB speakers, including President Christine Lagarde, drew much attention to this decision, and the euro rose slightly.
Investors will be watching Lagarde's regular press conference at 1:45 p.m. Japan time for hints about the future direction of interest rates.
inflation and growth
The ECB can finally claim that it has largely contained the worst inflation in at least a generation.
Inflation rose just 1.7% last month, falling below the bank's 2% target for the first time in three years. Inflation could rise slightly above 2% by the end of this year, but is expected to remain around that level for some time.
The ECB said wage hikes still supported “domestic inflation,” or rising prices for services and goods that are less dependent on imports, but that this was also weakening.
“Domestic inflation remains high as wages continue to rise at a high pace,” the report said. “At the same time, labor cost pressures are expected to continue to ease gradually, with profits partially cushioning the impact on inflation.”
But the economy had to pay a high price for it.
Economic growth has been stagnant for nearly two years as high interest rates reduce investment and economic growth. The latest data on industrial production and bank lending point to more of the same in the coming months.
Cracks are beginning to appear in what has been a highly resilient labor market, with vacancy rates, or the share of vacancies in total jobs, falling from record highs.
This has led to growing calls within the ECB to ease policy before it is too late.
Portugal's central bank's Mário Centeno said recently: “We now face new risks that could lead to below-target inflation and constrain economic growth.” “Lower jobs and reduced investment will only add to the proportion of sacrifices already endured.”
Some of its weaknesses stem from structural problems such as high energy costs and low competitiveness in Germany, Europe's industrial powerhouse.
These problems cannot be solved by lowering interest rates alone, but they can be improved to a certain extent by making capital cheaper.
“We cannot ignore the headwinds to growth,” said ECB board member Isabel Schnabel. “At the same time, monetary policy cannot solve structural problems.”
