The European Central Bank is expected to announce its first interest rate cut in eight years on Thursday.
The euro zone's key interest rate is expected to be cut by 25 basis points to 4.25%, after the Swiss National Bank and Swedish National Bank cut rates in March and May, respectively. If the ECB cuts rates, it will act before the Bank of England and the Federal Reserve, which meet in June.
Overall, the market is currently pricing in less than 0.60 percentage points of rate cuts in 2024, implying two cuts and a possible third. That's lower than in April, when markets were expecting three cuts, and in January, when at least five cuts were on the table, according to Reuters.
“A cut on June 6th seems all but certain, but any other outcome would send shock waves through markets on Thursday,” said Michael Field, European market strategist at Morningstar.
Eurozone inflation rises
The expected rate cut came despite a recent surge in euro zone consumer prices. Inflation has moved closer to the bank's 2% target, but both headline and core inflation rose more than expected in May and rose month-on-month for the first time in 2024.
Eurozone inflation rose to 2.6% year-on-year from 2.4% in April, Eurostat said on May 31. Core inflation, which measures prices excluding energy and food costs, also accelerated to 2.9% from 2.7% in April.
Will the ECB cut rates again in July?
Markets are now focused on the July 18 meeting, with Thursday's interest rate announcement likely to be watched for any indication of what's to come after June.
“It's understandable that the bank doesn't want to cut rates dramatically in a hurry and may be forced to reverse course if inflation rises further,” Field said.
“Whether there are further rate cuts this year or early next year, that won't change the situation either way. The ECB has signalled its intention to cut rates, so the timing is still not 100% clear, but at least the direction is clear.”
Pimco portfolio manager Konstantin Veit doesn't expect the ECB to give much guidance on Thursday, expecting the governing council to reaffirm its meeting-by-meeting approach and reliance on data.
“We therefore think it is unlikely that the ECB will commit to a particular interest rate path,” he said. But Pimco expects a cautious approach with a 0.25 percentage point move.
“There is certainly a risk that the numerically dominant doves on the ECB's Governing Council could seize the opportunity and push for a second rate cut in July,” Marco Wagner of Commerzbank's economic research department wrote in a May 31 note. “This would not be unlikely given low inflation in May and June.”
Monetary policy remains tight
“Dovish critics might argue that despite the first rate cut in June, real interest rates are unlikely to fall given the declining trend in inflation and monetary policy will remain tight. However, some Governing Council members, such as Estonia's Maddis Muller, have clearly voiced their opposition to a rapid further rate cut in July,” Wagner added.
“Others, such as Spain's Pablo Hernández de Cos, have said they will proceed cautiously after the June rate cut. Therefore, we still do not expect a rate cut in July.”
According to economists at Swiss bank J. Safra Sarasin, “Market prices are moving at a moderate pace of around 1.5%. [percentage points] “There will be rate cuts for the rest of the year. In our view, this is not a big deal. Inflation is trending downwards and economic growth remains sluggish after two years of stagnation. Policy is clearly restrained and the ECB can afford to be a bit more bold.”
They still expect three more rate cuts this year. “In our view, this is no big deal: inflation is trending downwards and economic growth remains sluggish after two years of stagnation. Policy is clearly restrained and the ECB can afford to be a bit bolder,” the analysts wrote in a May 29 note.
