ECB cuts interest rates for the first time in five years

Move is seen as the start of an easing cycle but bank may wait months before cutting it again

European Central Bank President Christine Lagarde speaks during a press conference following the bank's monetary policy meeting in Frankfurt.
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The European Central Bank cut interest rates for the first time in five years on Thursday, lowering them from a record high by 25 basis points to 3.75 per cent.

The move is seen as the start of an easing cycle, but lingering price and wage pressures are clouding the outlook and may force the euro zone's central bank to wait months before cutting again.

In lowering the rate, the bank has joined institutions in Canada, Sweden and Switzerland in starting to unwind steep rate increases used to tame a post-pandemic inflation surge.

“The governing council will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction,” the ECB said.

While the bank kept open its options for July, a string of influential policymakers, including board member Isabel Schnabel and Dutch central bank chief Klaas Knot have already made the case for a pause next month, suggesting the next window of opportunity for easing will be in September.

Economists expect another two rate cuts from the ECB this year, most likely in September and December, while markets are pricing between one and two additional moves – a big change from the start of the year, when more than five cuts were anticipated.

“Interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission,” the ECB added. “The governing council is not pre-committing to a particular rate path.”

Conservative policymakers, who still appear to command a majority on the rate-setting governing council, have argued that the ECB is not in any hurry to cut since a rebound in the economy proves high rates are not choking off growth.

Part of their caution may be due to unexpectedly stubborn inflation. The ECB raised its 2025 inflation projection to 2.2 per cent on Thursday from 2.0 per cent.

“Despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year,” the central bank said.

Some economists say the biggest risk to the rate cut schedule is the US Federal Reserve, not wages and inflation.

The Fed has clearly signalled a delay in policy easing, and a further delay in US rate cuts is likely to make the ECB more cautious too, as a widening interest rate differential would weaken the euro and raise imported inflation.

Attention now turns to ECB President Christine Lagarde's press conference, where she is likely to be grilled about the ECB's likely next moves.

Updated: June 06, 2024, 3:11 PM