The European Central Bank (ECB) left its key interest rate unchanged for the fourth time in a row at Thursday’s meeting. But the revised inflation outlook led investors to expect the first interest rate cut in June.
European equity markets moved higher on the lowered inflation outlook and the euro shed value against the US dollar.
The interest rate decision had been widely expected, and two thirds of economists now predict a first rate cut in June. The main refinancing operations and the interest rates on the marginal lending facility and the deposit facility were left unchanged at 4.50%, 4.75% and 4.00% respectively.
The ECB remained silent as to when rates may be cut. In the US, Fed chairman Jerome Powell emphasised on Wednesday that there was no hurry to cut interest rates.
First ECB Rate Cut in June?
The language in today’s statement accompanying the rate decision will interest investors, said Michael Field, European market strategist at Morningstar. “We believe there has been a discernible change in the tone used, in particular around the danger of inflation. This would indicate that the ECB is softening its stance on rates, ultimately preparing markets for a cut, which will likely come sooner rather than later.“
With the European economy teetering on recession, Field believes the ECB must now balance the (outside) risk of resurgent inflation, with the potentially more pressing need to ensure the economy doesn't enter a prolonged recession. “As such, June seems like a reasonable compromise for the first interest rate cut.”
The ECB revised down its inflation outlook, in particular for 2024, which mainly reflects a lower contribution from energy prices. The bank projects inflation to average 2.3% in 2024, 2.0% in 2025 and 1.9% in 2026. The projections for inflation excluding energy and food (core inflation) have also been revised down and average 2.6% for 2024, 2.1% for 2025 and 2.0% for 2026.
“Although most measures of underlying inflation have eased further, domestic price pressures remain high, in part owing to strong growth in wages”, the ECB says. “This softening in language we believe is justified given all the data points we have to hand,” Field says. Inflation in the eurozone fell to 2.6% year on year in February, down from 2.8% in January.
"Overall, the fight against inflation in the eurozone is on the right track," said Ulrich Kater, Chief Economist at DekaBank. “However, this is not yet over, as the ECB cannot be satisfied with 'almost' reaching its inflation target of 2% … interest rate cuts from June onwards remain likely, even if the pace could be slower and more cautious than many market participants would like.” The hope of interest rate cuts is also fuelled by the weakening economic outlook for the 20-country eurozone, as the central bank's forecast shows.
How Will Interest Rate Cuts Affect European Investors?
Equity markets tend to rise on anticipated rate cuts, while bond markets tend to suffer. On the other hand, with interest rates aleady being high, falling interest rates also mean lower bond yields, which pushes bond prices higher. And lower rates make existing bonds, and particularly those already issued during a period of high rates, more attractive for yields.
Meanwhile cash savings rates on bank accounts will likely decrease, meaning savers may start to get less for their holdings at the bank. On the other hand, lower rates will also make consumer debt and mortgage rates cheaper. In its latest Economic Bulletin, the ECB said lending rates on business loans declined slightly, to 5.2% in late 2023, while mortgage rates increased further to 4.0%.
