Image source, Getty Images
- author, Lucy Hooker
- role, BBC News Business Reporter
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The EU became the second major economy in the world to cut lending rates this week, citing progress in tackling inflation.
The European Central Bank (ECB) announced it would cut its key interest rate from a record 4% to 3.75%.
This follows Canada's decision on Wednesday to cut its official lending rate.
The ECB's move comes as voters face general elections across the EU over the next four days, the results of which are expected to reflect public discontent with the rising cost of living.
European Central Bank President Christine Lagarde said the inflation outlook had improved “significantly,” paving the way for interest rate cuts.
But it warned that inflation is likely to remain above the bank's 2% target until next year, averaging 2.5% in 2024 and 2.2% in 2025.
The president said the ECB would keep interest rate policy “sufficiently tight for as long as necessary” to bring inflation down to the bank's 2 percent target.
But, she added, “we are not committing in advance to a particular interest rate path.”
Lindsay James, investment strategist at Quilter Investors, said the rate cut was widely expected but would still come as a relief to consumers and businesses on the continent.
“The ECB is ahead of the Bank of England [US] “While the Fed may still be months away from cutting interest rates, some stimulus would provide a boost to an economy that desperately needs it,” she said.
Central banks have kept interest rates high for the past two years to keep inflation in check — most target an annual inflation rate of 2% — but high interest rates tend to slow economic growth.
Lower interest rates should lower borrowing costs for consumers and businesses, stimulating economic activity.
The EU's interest rate body met in Frankfurt on Thursday and decided to cut interest rates despite a slight increase in inflation in May, which rose in the 27-nation bloc to 2.6 percent from 2.4 percent in April.
The ECB's decision came after Canada cut interest rates on Wednesday, lowering its key policy rate to 4.75% from 5% after inflation fell to 2.7%. Sweden and Switzerland also cut rates.
Largarde offered a broader assessment of the euro zone's economic outlook: “We need to look to the future, so overall confidence in the path forward is increasing,” he said.
But she also warned of possible “challenges” ahead for the region.
“Risks to economic growth are balanced in the near term but remain tilted to the downside over the medium term,” she said, citing conflicts in Ukraine and the Middle East.
It warned that geopolitical tensions could weigh on growth, while extreme weather and the climate crisis could push up broader food prices.
but, Catherine Nice, chief European economist at investment firm PGIM, said she was “fairly confident” the ECB would cut rates further over the summer or fall, bringing euro zone interest rates to below 3.5% by the end of the year.
“Economic growth has recovered strongly from the recession that the eurozone experienced towards the end of last year but remains weak,” he told the BBC's Today programme.
This factor, combined with slowing inflation and wage growth, would justify further rate cuts, she said.
UK elections become more complicated
UK interest rates have not yet started to fall, but there is speculation the Bank of England could cut rates as early as this month.
UK inflation has fallen to 2.3%, well down from a peak of more than 11% in late 2022.
Last month, the International Monetary Fund suggested the Bank of England should cut interest rates to 3.5% from the current 5.25% by the end of the year.
But Polar Capital's George Godber said the UK's upcoming election would “complicate” the Bank of England's next decision on June 20.
Godber said while the central bank is politically independent, the Conservative government had made interest rate cuts part of its pledge to voters and that could influence “mindset”.
“If we cut it, it becomes political, and if we don't cut it, it becomes political,” he said.
The Federal Reserve is also expected to cut interest rates in the coming months, although the latest inflation rate in the US is high at 3.4%.
Godber said the Fed is likely to make its first moves on interest rates just before the November vote.
