Eurozone Interest Rates Cut as Inflation Battle Shows Progress
The European Central Bank (ECB) announced on Thursday that it has cut interest rates for the 20 countries using the euro currency. The main deposit rate has been reduced from a record high of 4% to 3.75%, following two-and-a-half years of progress in the battle against inflation.
ECB President Christine Lagarde stated last month that the pace of price increases was now “under control”, leading to the decision to lower interest rates. Despite this positive development, the Bank emphasized in a statement that the fight against inflation is not yet won. This signals a cautious approach to future policy decisions based on data.
The Bank also revised its inflation forecasts for this year and the next, with a projected average of 2.4% in 2021 and 2.2% in 2025. However, there is still a mixed picture for price stability across the eurozone, with some member states in the east reporting higher inflation rates.
The Bank’s decision to cut rates, which was made ahead of the US Federal Reserve and the Bank of England, was widely expected due to previous guidance and the confidence expressed by President Lagarde in the path of inflation. However, some economists and financial market commentators believe that the ECB may have acted prematurely.
The latest inflation reading for the eurozone in May showed a rise from 2.4% to 2.6%. Additionally, services inflation remains stubbornly high in both the euro area and the UK. As a result, the Bank of England is not expected to make any rate cuts until at least August.
Gabriele Foà, a portfolio manager at Algebris Investments, believes that the ECB’s decision may be viewed as a policy mistake in the future. JPMorgan economist Greg Fuzesi described the move as “oddly rushed”, while Lorenzo Codogno, an economist at LC Macro Advisors, stated that the economic data does not support a rate cut at this time.
There is also a risk that the ECB’s rate cut could lead to additional inflation through a weaker euro. Traditionally, interest rate cuts are not supportive of a domestic currency, which can make goods and services more expensive when bought in other currencies such as the US dollar and British pound.
However, the ECB’s caution on future rate cuts has limited movements in the currency markets, with the euro rising slightly against both the dollar and pound. Additionally, the ECB is not acting alone in its decision, as other central banks such as Canada, Sweden, and Switzerland have also cut rates.
The ECB does not expect to reach its target inflation rate until “well into” next year. Economist Holger Schmieding from Berenberg predicts that more easing may be necessary in the future, especially if there are any new inflation surprises. He also believes that the ECB may have overreacted with its previous rate hikes, making lower rates a sensible decision.
