ECB cuts key interest rate by 25 bps even as inflation fight continues

The European Central Bank went ahead with its first interest rate cut since 2019 on Thursday, citing progress in tackling inflation even as it acknowledged the fight was far from over.
 

In new forecasts released with the widely flagged rate cut, the ECB said it expected inflation to average 2.2% in 2025 - up from a previous estimate of 2.0% and meaning it was now seen holding above the central bank's 2% target well into next year.
 

Inflation in the 20 countries that share the euro has fallen to 2.6% from more than 10% in late 2022, largely thanks to lower fuel costs and an easing of post-pandemic supply snags.
 

But that progress has stalled recently and what had looked like the start of a major ECB easing cycle only a few weeks ago now appears more uncertain due to signs that inflation may prove sticky, as it has in the United States.
 

Cutting its deposit rate to 3.75% from a record-high 4.0%, the ECB gave no indication whether that would be followed by a further easing in July.
 

"We are not pre-comitting to a particular rate path," ECB President Christine Lagarde told a press conference, reading from the Governing Council's statement.

"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." While ECB policymakers signalled their confidence that inflation was gradually being tamed, there was also enough caution in their statement to convince some ECB-watchers that Thursday's cut would 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," said Diego Iscaro, head of European economics at S&P Global Market Intelligence.
 

Lagarde said only one Governing Council member had opposed the decision to cut rates. Three sources told Reuters that was Austrian central bank chief Robert Holzmann, who had cited the rise in inflation projections as grounds to stay put.

With Thursday's move the ECB joins the central banks of Canada, Sweden and Switzerland in undoing some of the steepest streaks of interest rate hikes in recent history.
 

Some commentators have questioned the logic of moving now, however, especially as the U.S. Federal Reserve has been stopped in its tracks by some stronger-than-expected inflation readings and is not expected to move till after the summer.
 

LAST MILE

Money market investors trimmed their bets on rate cuts after Thursday's announcement and only priced in one more, with a chance of a second, for the remainder of the year.
 

Asked if the ECB was moving into a phase of "dialling back" its tight monetary policy stance, Lagarde said she could not confirm such a process was underway, but that there was "a strong likelihood".
 

"But it will be data-dependent, and what is very uncertain is the speed at which we travel and the time that it will take," she added, noting there would be "bumps on the road" ahead.
 

Stronger-than-expected data about euro zone inflation, wages and economic activity over the last few weeks has fuelled fears of a more difficult "last mile" on the way to the ECB's goal - a concern expressed by influential board member Isabel Schnabel.

Inflation in services, which some policymakers have singled out as especially relevant because they reflect domestic demand, has been a particular concern after a rise to 4.1% in May from 3.7% a month earlier.
 

At the same time, a rebound in growth also reduced the urgency for the ECB by undermining the argument that high rates are choking economic activity.
 

But the real elephant in the room may remain the Fed and whether it starts or further delays its own easing cycle.
 

A more restrictive Fed would likely mean a weaker euro and higher imported inflation for the currency bloc, but it would also increase yields on global bond markets - a double whammy whose net effect is hard to predict.
 

"The pace of rate cuts will be dependent on the U.S. and the Fed," Mohit Kumar, an economist at Jefferies, said. "In the event that 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."