It has not been an easy or quick task, but finally The Governing Council of the ECB has taken the decision to lower interest rates: from 4.5% to 4.25%. It was as expected, the institution itself had been pointing out for months that June would be the moment for the change of course, an aspect on which all voices sounded in unison. Inflation, the great workhorse of the ECB during the last two years, is finally showing signs of weakness. The central bank can now change course in its policy and mark the beginning of a path of declines in the price of money that is expected to still be very uncertain and full of obstacles and for which the bank refuses to commit dates. This was explained in its statement today: “The Governing Council will continue to apply a data-dependent approach, in which decisions are made at each meeting, […] without committing in advance to any specific path of rates.” In addition to the main interest rate, used for loan operations to banks, the monetary authority has cut the deposit rate (the interest paid to banks that leave their money in the ECB) by a quarter point, to 3. 75% and the marginal credit rate at 4.5%.
In any case, companies and governments will be able to start financing themselves at a somewhat cheaper cost after having adjusted to interest rates that have reached their highest levels since 2001. The announced cut is limited and timid, especially in comparison with the more violent rise in the history of the euro: from zero rates in July 2022 to 4.5% reached in September of last year, with two increases of 75 basis points (unprecedented for the ECB), four of half a point and another four of 0.25. Two years of heavy hand in which the cost of financing has skyrocketed and the banks have turned off the credit tap. And, although economic growth has been anemic (barely 0.4% in the euro zone by 2023), the ECB has saved the big ball: the monetary union has been able to avoid recession, understood as two consecutive quarters with negative growth. The intensity of the rate hike has had a lot to do with the genesis of the inflationary process. Triggered by the cost of energy after the Russian invasion of Ukraine, economists initially judged it to be a transitory phenomenon, but it ended up taking root, forcing a forceful response. The ECB’s objective was to cool the economy in order to stop the upward spiral in prices, and it seems to have succeeded: the inflation rate in the euro zone reached a maximum of 10.6% in October 2022 and it is not until now that Prices are growing at a rate of 2.6%, according to May data, when the ECB agrees to ease up. A level that is already close to its unavoidable objective of 2%.
However, the most recent indicators do not yet allow us to give any indication. The bank, in fact, has raised the inflation forecast for the eurozone for 2024 and 2025. It expects an underlying CPI (without taking into account food and fuel) of 2.8% (compared to 2.6% previously) in 2024 and 2.1% in 2025 (from 2% previously). Nor does he see clear signs, strong enough, to commit to new cuts: “Despite the progress made in recent quarters, domestic inflationary pressures remain intense due to high wage growth, and inflation is likely to continue above of the goal until well into next year.” In fact, its general CPI forecast also increases two tenths compared to March forecasts, from 2.3% to 2.5% for this year and from 2% to 2.2% for 2025. The ECB has also improved its growth outlook, at 0.9% this year, compared to the 0.6% estimated in March, although it has slightly adjusted downwards the forecast for 2025, of GDP growth of 1.4% from 1, 5% expected in March. For 2026, the estimated GDP increase of 1.6% is maintained.
Christine Lagarde has highlighted on several occasions, in her press appearance, that the bank makes its decisions meeting by meeting and based on the available data. Thus, the president of the ECB has indicated that, although inflation and core inflation have moderated, “the prices of services have risen significantly.” This indicator, the most inflationary among the different price measures, grows at a rate greater than 4%. She has also mentioned Lagarde salaries, “which have continued to grow at an accelerated rate.” In the first quarter they increased by 4.7%, compared to 4.5% in the fourth quarter of 2023. These figures reinforce the warnings that the decline in inflation is going to be uncertain and bumpy and that above all they give arguments to the hardliners. of the Governing Council of the institution in its defense of going very slowly, with lead feet, with rate cuts.
In fact, at the April meeting there were already voices that advocated lowering rates at that time. With the decision delayed until June, an intense debate is now opening up about when to undertake the second cut. A new edition of the tug of war between falcons (supporters of a tougher monetary policy) and pigeons (favoring softer policies that do not lose sight of growth) that dominates the debates in the Governing Council. Last week, Frenchman François Villeroy de Galhau defended the “significant margin” that the ECB has to make its policy more flexible. “Sometimes I read that we should cut back The types only once a quarter, when new economic projections are available and therefore exclude July. Why, if we do it meeting after meeting and rely on data? I’m not saying we should commit already in July, but let’s maintain our freedom in terms of timing and pace,” he declared. On the contrary, the German Isabel Schnabel, a member of the executive committee of the ECB, was already advancing at the end of May that a rate cut in July “does not seem justified.” A position that has also recently been joined by two renowned falcons: the president of the Bundesbank, Joachim Nagel, and the governor of the Austrian National Bank, Robert Holzmann.
Investors are contemplating between one and two more rate cuts by the ECB in the remainder of the year, a forecast that will depend greatly on what the Fed does, which does not foresee a rate cut until at least September. “Our base case remains an ECB cut in June, September and December. But the pace of interest rate cuts will also depend on the US and the Fed. In the event that the Fed does not cut interest rates this year (which is not our base case), we could see only two cuts by the ECB in 2024,” says Mohit Kumar, Jefferies’ chief economist in Europe. Interest rates have begun their downward path today, but the pace at which they do so remains to be seen, in an economic scenario where questions abound and certainties are scarce. Although one thing is clear: the unusual fact of having interest rates below zero, which allowed Germany or Spain to make money by simply issuing debt, ended in 2022.
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