The European Central Bank cut interest rates on Thursday as widely expected, with all but one governing board member supporting a 0.25 percentage point cut to the ECB's three rates. At the same time, the ECB raised its inflation outlook for 2024 and 2025 and declined to detail its rate-cutting path, signalling that further cuts may be slow in coming.
- Main refinancing rate: 4.25%, down from 4.50%
- Marginal lending facility rate: 4.50%, down from 4.75%
- Deposit facility rate: 3.75%, down from 4.00%
European stocks retreated, with the Stoxx Europe 600 Index erasing most of the day's earlier gains. The euro briefly strengthened against the dollar before returning to the day's trading range.
ECB president Christine Lagarde did not provide guidance on a future rate cut path echoeing previous statements that the ECB's governing council will follow a data-dependent, meeting-by-meeting approach.
"I think the direction of travel is concrete now, but just the pace of cuts might be slower than initially expected," Morningstar strategist Michael Field remarked after the announcement.
"Based on an updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission, it is now appropriate to moderate the degree of monetary policy restriction after nine months of holding rates steady", the introductory statement read.
This is the first interest rate cut for the deposit facility in five years and follows 10 rate hikes since the Frankfurt-based institution began its rate hiking cycle in July 2022.
Prior to Thursday's announcement, markets priced in a 12% likelihood of a further ECB cut at its July 18 meeting, and a 63.4% chance of a cut in September. Whether there'll be a third cut in 2024 is hotly debated and markets are no longer pricing in more than two cuts.
"The last thing the ECB would want to do is to have to raise rates if next month's inflation numbers flare up again. So the cure is to not be rushed into decisions", according to Morningstar's Field. “We’ve come a long way from the 10.6% highs in inflation, witnessed just 18 months ago, and at this point lower interest rates seem appropriate."
The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be revised down by 0.25 percentage points each to 4.25%, 4.50% and 3.75% respectively, effective June 12, according to the statement.
ECB Raises Inflation Outlook for 2024 and 2025
The latest Eurosystem staff projections for both headline and core inflation have been revised up for 2024 and 2025 compared with the March projections. Staff now see headline inflation averaging 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026. For inflation excluding energy and food, staff project an average of 2.8% in 2024, 2.2% in 2025 and 2.0% in 2026. Economic growth is expected to pick up to 0.9% in 2024, 1.4% in 2025 and 1.6% in 2026.
ECB Cuts Rates Ahead of the Fed for the First Time
The ECB governing council wrote history as it acted ahead of its US counterpart in a rate move. But the cut followed similar moves of other major Western central banks. The Swiss National Bank was the first major bank to announce a rate cut in March, followed by Sweden's Riskbank in May. On Wednesday, the Bank of Canada announced it will cut its overnight rate to 4.75% after six consecutive pauses.
The US Federal Reserve and Bank of England will announce their monetary policy decisions on June 12 and 20, respectively. In the US, rate cuts are delayed owing to first quarter inflation surprise, says Preston Caldwell, Morningstar's US economist. "Our year-end 2024 federal funds rate expectation moves to 4.75%-5.00% from 4.25%-4.50% previously."
How Far Will European Interest Rates Fall?
Most analysts agree that the ECB will keep rates unchanged at its July 18 meeting, but resume cuts at a slow pace of 0.25 percentage points at its September 12 meeting.
"Had the ECB not telegraphed the rate cut this week so emphatically, we believe that there would have been a heated debate around whether to wait for more data following the less than supportive wage and inflation prints over the last couple of weeks. It is highly likely that Lagarde will guide markets to a hold at July, with the next adjustment either in September or October", Dave Chappell, Senior Fund Manager, Fixed Income at Columbia Threadneedle Investments, said in a note ahead of the ECB decision.
Karsten Junius, Chief Economist at J. Safra Sarasin Sustainable, agrees that a September rate cut is the most likely scenario. "We believe that monetary policy has been too restrictive for too long. We therefore expect further rate cuts in September, October and December, towards a level of 3.0% by the end of the year. For their part, the markets are currently pricing in a level of 3.3% for December", he said in a note prior to Thursday's meeting.
"In our view, financial markets do not expect sufficient rate cuts this year. The euro area clearly differs from the United States and we expect the ECB to act independently of the Federal Reserve and according to its domestic needs."
Kathleen Brooks, research director at XTB, expects two more cuts this year. "The market is currently pricing in the prospect of two further rate cuts this year, and rates in the Eurozone are expected to end 2024 at 3.25%, compared with 4.84% for the US", she said on Thursday morning.
How Will Interest Rate Cuts Affect Markets?
Equity markets tend to rise on anticipated rate cuts. In bond markets, falling interest rates mean lower yields, which pushes bond prices higher. Lower rates also 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, to the detriment of savers. Borrowers, by contrast, stand to benefit from lower rates as consumer debt and mortgages become cheaper. In its latest Economic Bulletin, the ECB said lending rates on business loans have already declined slightly, to 5.2% in late 2023, while mortgage rates increased further to 4.0%.
• Clarification (June 6, 2024): The first version of the article said this was the first interest rate cut in eight years. While the main refinancing rate and marginal lending facility were last cut in 2016, the deposit facility rate was last reduced in 2019.
