The European Central Bank (ECB) on Thursday cut interest rates for the first time since 2019 as euro zone inflation gradually eased, but President Christine Lagarde warned that the path ahead was unclear and would be “difficult”.
The key deposit rate was cut by 0.25 percentage point from its record low to 3.75%.
Following an unprecedented series of interest rate hikes in the euro zone from mid-2022 to tame soaring energy and food costs, inflation has been slowly falling towards the ECB's 2% target.
Thursday's rate cut would be the first since September 2019 but the central bank has kept rates unchanged since October, providing a much-needed boost to the struggling euro zone economy.
The move represents a divergence of opinion between the Federal Reserve and the ECB, which has also been aggressively raising interest rates but is expected to take several months to begin cutting rates due to better-than-expected economic data.
All eyes are on what happens next, but recent better-than-expected inflation and growth data have complicated the path forward and reduced the likelihood of a rapid easing cycle.
Speaking at a press conference after the rate decision, Lagarde insisted the Frankfurt-based central bank was “not committing in advance to a particular interest rate path.”
“What's very uncertain is how fast we'll move and how long it will take,” she said. “We know it's going to be a difficult road.”
– Persistent inflation –
The ECB's latest forecasts, published on Thursday, highlight the challenges.
The central bank raised its inflation forecasts for this year and next, saying it no longer expects the inflation gauge to reach its 2% target in 2025 as previously expected, but rather sees it at 2.2%.
The company also raised its growth forecast for 2024, though it made a slight downward revision for next year.
Data released last week showed inflation in the 20 countries that use the euro rose 2.6 percent year-on-year in May, a faster-than-expected rate.
The eurozone economy also emerged from recession, expanding at a faster pace than expected in the first quarter.
Lagarde noted that while inflation has eased, it remains elevated, noting that “wages remain rising at a high pace, compensating for previous spikes in inflation.”
But he also said some indicators suggest wage growth will slow later this year.
Lagarde said the euro zone economy is expected to continue recovering.
But she also warned of risks ranging from a weakening global economy to escalating trade tensions, and pointed to conflicts in Ukraine and the Middle East as “major sources of geopolitical risk.”
– Concerns over discrepancies –
With data volatility and uncertainty about the future, the ECB is seen as unlikely to cut rates further at its next meeting in July.
Instead, some analysts believe policymakers would prefer to cut rates at their biweekly meetings (or once a quarter, as the bank meets every six weeks) while also issuing regularly updated forecasts.
Carsten Brzeski, an economist at ING, believes the central bank could follow this path, but warned that things could turn out differently.
“It probably wouldn't take a big enough inflation surprise for the ECB to act more cautiously or reverse today's rate cut,” he said.
In the United States, better-than-expected economic data has reduced expectations of when the Federal Open Market Committee will start to cut borrowing costs when it next meets on June 11-12, raising speculation the ECB may also keep policy on hold.
However, euro zone interest rate setters have stressed that they will set their own policy.
But there are concerns about the ECB cutting interest rates at a faster pace than the U.S. central bank, which could raise the cost of imports into the euro zone, leading to a weaker euro and fuel inflation.
Quilter Investors' Lindsay James predicted the ECB “may pause mid-way through cutting rates to limit the extent of its divergence from the Fed.”
