The European Central Bank (ECB) has signalled that it will cut interest rates from their historic highs at its 6 June meeting. This would mean the ECB would be one of the first major central banks to cut rates, having been criticised for being one of the last to raise them after the biggest inflation surge for a generation 3 years ago.
ECB Chief Economist Philip Lane told the Financial Times in an interview, “Barring major surprises, at this point in time there is enough in what we see to remove the top level of restriction.”
Markets now expect that the ECB will lower its benchmark deposit rate by 25 basis points from its record high of 4% down to 3.75% at its next meeting after Eurozone inflation fell close to the bank’s 2% target.
The Swiss, Swedish, Czech and Hungarian central banks have already cut rates this year in response to falling inflation. But among the world’s major economies, the Fed and Bank of England are not expected to cut rates before closer to year-end, and the Bank of Japan is considered likely to continue raising them.
Source: Financial Times
A key reason why inflation had fallen faster in the Eurozone than in the US was because the region had been hit harder by the energy shock triggered by Russia’s invasion of Ukraine.
Lane said ECB policymakers needed to keep rates in restrictive territory this year to ensure that inflation kept easing, however, he said the pace at which the central bank lowered Eurozone borrowing costs would be decided by the data, “Is it proportional, is it safe, within the restrictive zone, to move down”.
Despite recent data showing Eurozone wage growth picked up at the start of this year, Lane said, “the overall direction of wages still points to deceleration, which is essential”.
Some analysts have warned that if the ECB diverges from the US Federal Reserve (Fed) by cutting rates more aggressively, it could cause the euro to depreciate and push up inflation by raising the price of imports. Lane said the ECB would take any “significant” exchange rate move into account, but pointed out “there has been very little movement” in this direction. The euro has rebounded by 20% against the USD from a six-month low in April, and it remains up over the past year.
Eurozone inflation has fallen from above 10% at its peak in 2022 to a near three-year low of 2.4% in April. Because there is “still significant amount of cost pressure” coming from rapid wage growth pushing up services prices, the ECB would probably have to keep policy fairly restrictive until 2025.
How far the ECB cuts rates will hinge on its assessment of the so-called neutral rate, the point at which savings and investment are balanced, where output is at an economy’s potential and inflation is at target.
Estimates of the neutral rate vary but Lane said it was likely to imply a policy rate at or just above 2%, although this could be higher if “a vigorous green transition” to renewable energy or vast gains from generative artificial intelligence prompted a surge in investment.
Source: Financial Times
