The European Central Bank (ECB) implemented its first interest rate cut since 2019 on Thursday, indicating progress in addressing inflation while acknowledging the battle is far from over.
In its new forecasts accompanying the anticipated rate cut, the ECB projected inflation to average 2.2% in 2025, up from a previous estimate of 2.0%.
This suggests inflation will remain above the ECB’s 2% target into the next year.
Inflation in the eurozone, comprising 20 countries, has decreased to 2.6% from over 10% in late 2022, thanks to lower fuel costs and eased post-pandemic supply issues.
However, this progress has recently stalled, and what seemed to be the start of a significant ECB easing cycle has become uncertain due to persistent inflation, similar to the situation in the United States.
The ECB reduced its deposit rate to 3.75% from a record-high 4.0%, without indicating if further easing would follow in July.
“We are not pre-committing to a particular rate path,” ECB President Christine Lagarde stated during a press conference, emphasizing that despite recent progress, domestic price pressures remain strong due to elevated wage growth, and inflation is likely to stay above target well into next year.
Although ECB policymakers expressed confidence in gradually taming inflation, their cautious statement led some analysts to believe that Thursday’s cut might not be repeated at the next meeting.
“In our view, this suggests that it is unlikely we’ll see back-to-back cuts in July,” commented Diego Iscaro, head of European economics at S&P Global Market Intelligence.
Lagarde noted that only one Governing Council member, Austrian central bank chief Robert Holzmann, opposed the rate cut, citing the rise in inflation projections as a reason to maintain current rates.
The ECB joins the central banks of Canada, Sweden, and Switzerland in partially reversing some of the steepest interest rate hikes in recent history.
However, some commentators question the timing, particularly as the U.S. Federal Reserve has paused due to stronger-than-expected inflation readings and is not expected to act until after summer.
Money market investors reduced their rate cut expectations following Thursday’s announcement, now only pricing in one more cut, with a possibility of a second, for the rest of the year.
When asked if the ECB was entering a phase of “dialing back” its tight monetary policy, Lagarde stated she could not confirm such a process but mentioned a “strong likelihood” depending on data.
She cautioned that there would be “bumps on the road” ahead.
Recent stronger-than-expected data on eurozone inflation, wages, and economic activity have fueled concerns about the challenging “last mile” towards the ECB’s goal, a concern voiced by influential board member Isabel Schnabel.
Inflation in services, particularly reflecting domestic demand, rose to 4.1% in May from 3.7% in April, causing particular concern.
At the same time, a rebound in growth has reduced the urgency for the ECB by weakening the argument that high rates are stifling economic activity.
However, the Federal Reserve’s actions remain a significant factor.
A more restrictive Fed would likely weaken the euro and increase imported inflation for the eurozone, while also raising global bond market yields, making the overall impact difficult to predict.
“The pace of rate cuts will be dependent on the U.S. and the Fed,” said Mohit Kumar, an economist at Jefferies.
“If the Fed doesn’t cut rates at all this year – not our base case – we could see only two cuts from the ECB this year.”