ECB Rates: Impact of the Cut on Markets and the Economy

The ECB Cuts Rates for the First Time Since 2019

The European Central Bank (ECB) announced a rate cut on Thursday, 6 June, lowering the deposit rate from 4% to 3.75%, the benchmark rate from 4.50% to 4.25%, and the marginal lending rate from 4.75% to 4.50%. This hasn’t happened since 2019.

This decision was made despite inflation forecasts being revised upwards, indicating a slow and irregular path for rate reductions.

Future Interest Rate Decisions

Christine Lagarde, President of the ECB, emphasized that future rate decisions will be made “meeting by meeting” and warned of a bumpy path ahead. She added: “Today’s rate cut reflects the confidence we have in the growth path, but to continue this process, we must wait for analyses to confirm that we are in economic recovery.”

Despite the rate cut, the ECB provided no precise guidance on future moves, stressing that inflationary pressures remain high. Updated forecasts show average inflation of 2.5% for 2024, 2.2% for 2025, and 1.9% for 2026.

Impact on the Labour Market and Economy

The ECB revised its growth forecasts for 2024 upwards, now estimated at 0.9% compared to the 0.6% predicted in March. However, prospects for 2025 were slightly reduced to 1.4%, while those for 2026 remain unchanged at 1.6%. This scenario indicates moderate economic growth in the coming years, with inflation likely to stay above the 2% target until 2025.

Lagarde indicated that wage growth, although still high, is expected to slow down during the year, helping to reduce inflationary pressures. However, rate cuts are likely to slow, with inflation remaining above the ECB’s target for most of 2025. This implies that the ECB will closely monitor various economic indicators to determine future monetary policy.

Consequences of the ECB Rate Cut

The ECB’s rate cut will have several consequences:

• Reduction in credit costs: Households and businesses will benefit from lower interest rates on loans, thus promoting access to credit and stimulating consumption and investment.
• Impact on savers: Lower interest rates may penalise savers, reducing returns on bank deposits and government bonds.
• Stimulus to economic growth: Lower borrowing costs should encourage spending and investment, supporting economic growth. However, the effectiveness of this measure will also depend on global economic conditions and domestic demand.
• Inflation and wages: The rate cut could influence inflation and wage dynamics. Although Lagarde has signalled that wage growth will slow, inflation may remain high in the short term, further complicating the ECB’s future decisions.

Market Reactions

Financial markets had anticipated the rate cut, pricing in a 25 basis point downward move. Following the rate cut announcement, eurozone government bond yields rose significantly. In particular, the 10-year German bond yield increased by nearly 8 basis points to 2.573%, while the 2-year bond yield rose by just under 6 basis points to 3.033%. Yields on Italian and Spanish 10-year government bonds also rose by 9 and 7 basis points, respectively, to 3.893% and 3.299%.

International Comparison

Despite starting to raise rates later than other central banks, the ECB is now leading with the June cut. The US Federal Reserve, for instance, is still grappling with higher inflation. Other countries like Canada, Sweden, and Switzerland have already started to reduce interest rates in the current cycle.

The ECB has clarified that future moves will depend on economic data and that there is no predetermined path for further rate cuts. With inflation still above target and moderate economic growth, the future of European monetary policy remains uncertain, requiring constant attention and careful assessment of all variables at play.