ECB to begin cuts but path beyond gets murkier

THE European Central Bank (ECB) is poised to start lowering interest rates from record highs, confident that inflation is sufficiently contained to ease the burden on the economy.

After being held at a peak of 4 per cent for nine months, analysts polled by Bloomberg almost unanimously predict that the deposit rate will be reduced by a quarter-point to 3.75 per cent on Thursday (Jun 6) – a step ECB officials have widely telegraphed in recent weeks.

Despite a bumpier retreat in price growth towards the 2 per cent goal, president Christine Lagarde declared in May that inflation in the 20-nation eurozone is “under control” following its historic spike. That’s put the ECB on course to loosen monetary policy before either the US Federal Reserve or the Bank of England, where the problem is proving more stubborn.

Where the ECB goes from here is unclear, with views becoming more cautious in the wake of data showing stronger-than-anticipated economic growth, inflation and wage increases. While most economists reckon there will be three rate cuts this year, investors have pared back their expectations and are only fully pricing two.

Lagarde will discuss the situation at a 2.45 pm briefing in Frankfurt – 30 minutes after the ECB’s policy announcement.

Interest rates

Officials have fuelled long-standing expectations of this week’s 25 basis-point cut. Even hawkish Governing Council members such as Bundesbank president Joachim Nagel and Executive Board member Isabel Schnabel have maintained that there are sufficient grounds for such a move.

That level of commitment has raised some eyebrows following the recent batch of economic reports.

“If they were consistent with their reaction function, they should actually be holding this week,” said Soeren Radde, an economist at Point72. “Which tells you that it’s a political compromise they came up with.”

Anatoli Annenkov, an economist at Societe Generale, called the latest data “not unambiguously supportive of policy easing, leaving a question mark as to why policymakers have been so focused on June, already since early this year”.

Some have spoken out against a second straight cut in July, though Bank of France governor Francois Villeroy de Galhau wants that option to remain available and Italy’s Fabio Panetta argues that policy will remain tight even after several cuts.

The focus is increasingly on the quarterly meetings for which fresh economic projections are produced – June, September and December – because that’s also when more of the relevant data on wages, corporate profits and productivity is available, as Dutch central bank chief Klaas Knot has stated.

New forecasts

Economists do not expect material shifts in this round of ECB forecasts, which they reckon will again show inflation returning to target in 2025. There may be an upward revision for growth this year, however, after first-quarter gross domestic product topped estimates.

One figure to watch is core inflation for 2026, which is currently seen at 2 per cent. An increase may be taken as a signal that the bar for further monetary easing is high.

Another wrinkle is that these projections are put together by national central banks, alongside ECB staff. In the past, “there has been a sense” that this setup can lead to more hawkish outcomes, according to JPMorgan economist Greg Fuzesi.

Global backdrop

While the ECB looked set to diverge from the Fed until recently, the stickiness of some inflation categories in Europe is prompting comparisons to the challenge faced by officials on the other side of the Atlantic.

US policymakers have to had to rethink monetary loosening after price gains surpassed expectations, even if traders are still hopeful of a rate cut this year. The Bank of England is also unlikely to cut this month, while the Bank of Canada did so on Wednesday.

Within Europe but outside of the eurozone, Sweden’s Riksbank and the Swiss National Bank are among those to have already begun to ease policy. BLOOMBERG