On Thursday, June 6, the European Central Bank decided to cut interest rates for the first time in five years.
It is worth noting that the mentioned decision of the main European financial regulator did not dispel a kind of twilight of uncertainty and misunderstanding about what the ECB’s next actions will be as part of the implementation of monetary policy. For investors, the corresponding state of affairs is largely negative, since they do not have the opportunity to form at least a preliminary picture of the future. The current situation is also significantly aggravated by the fact that there is currently no certainty in the context of assessing the prospects for the dynamic of inflation in the European Union shortly. It is worth noting that the growth in the cost of goods and services in this region slowed down sharply last year, but so far there are no signs that the momentum of the corresponding tendency continues to maintain its strength or signals a guaranteed ongoing materialization in the space of economic reality.
On Thursday, the ECB cut the record-high deposit rate by 25 basis points. Now this indicator is at 3.75%. As part of the decision to ease monetary policy, the ECB joined the central banks of Canada, Switzerland, and Sweden, which also began lowering the cost of borrowing, even though the Federal Reserve System has so far taken a very cautious approach in the context of the relevant issue, stating that for such actions it is necessary to obtain positive data on the dynamic inflation in the next few months. The position of the United States financial regulator is important in the context of global economic reality. The state of affairs in the US economy has an impact on the situation in other countries. ECB Executive Board member Isabel Schnabel, during a speech in 2022, announced the existence of tangible evidence of the globalization of inflation.
Since the end of the coronavirus pandemic, there has been what can be described as a scaling up of monetary policy tightening around the world. In various countries, central banks have applied measures in the form of interest rate increases as part of efforts aimed at curbing the pace of the inflationary process.
The decision of the European financial regulator, which became known on Thursday, according to media reports, is the beginning of a cycle of monetary policy easing. At the same time, in the context of the peculiarities of the current configuration of economic reality in the EU, a situation is emerging when the first action has been performed as part of a long-term process, but the prospects for subsequent such steps are more than uncertain. Nowadays, in the mentioned region, such a circumstance as inflationary pressure on prices and wages still continues to be in force. Against this background, the prospects for continuing the implementation of the ECB’s monetary policy easing strategy are significantly weakening. It is worth noting that maintaining the mentioned pressure does not mean that the conditions of economic reality will not allow the European financial regulator to cut interest rates again in the current year. In this case, it is implied that, most likely, the ECB will not make such a decision in the coming months.
The official statement of the European financial regulator, released on Thursday, notes that the Governing Council will continue to follow a data-dependent and meeting-by-meeting approach to determine the necessary level of restrictive measures and their optimal duration.
The ECB has plans to continue easing monetary policy in July. At the same time, some officials believe that the mentioned decision should be abandoned next month. Isabel Schnabel and the chief of the Dutch central bank, Klaas Knot, argue that the ECB should pause in July in the framework of monetary policy easing actions. Moreover, in their opinion, the circumstances of the economic reality in the EU will form the conditions for another interest rate cut in September.
The expert community is also dominated by the opinion that the European financial regulator will not lower the cost of borrowing until the autumn. This view assumes that the ECB will cut interest rates in September and December. It is worth noting that at the beginning of 2024, the opinion was actively spreading in the expert community that in the current year the European financial regulator would lower the cost of borrowing over five times.
The ECB’s official statement notes that interest rate decisions will be made based on an assessment of the prospects for the dynamic of inflation. In this case, the regulator will take into account economic and financial data, the rate of underlying inflation, and the effectiveness of the implemented monetary policy. The ECB also separately noted that the Governing Council is not pre-committing to a particular rate path.
Representatives of the European financial authorities, who adhere to a conservative point of view on potential options for responding to what is happening in the space of economic reality, say that in nowadays terms there is no need for any quick actions and decisions in the context of monetary policy easing. According to them, the mentioned approach is justified by the fact that high interest rates are not a factor limiting economic growth. They note that it is for this reason that the ECB should not rush into easing monetary policy. It is worth noting that currently conservative officials have a majority in the Governing Council.
Today, there is stubborn inflation in the EU, which came as a surprise to many. This fact of objective economic reality suggests that the ECB is likely to refrain from making quick decisions on cutting interest rates shortly. It is also worth noting that on Thursday the European financial regulator published a forecast according to which inflation in the EU next year will be fixed at 2.2%. In this context, it is important that the previous version of the mentioned forecast provided for an increase in the cost of goods and services at the level of 2%. The ECB also expects inflation to be fixed at 2.5% in the current year. The previous version of the forecast for 2024 provided that the cost of goods and services will increase by 2.3%.
Dean Turner, the chief eurozone economist at UBS Global Wealth Management, says that the inflation prospects contained in the ECB’s specified outlook are evidence that this financial regulator will still make decisions on cutting interest rates this year. The expert noted that currently there is no understanding as to when exactly the circumstances favorable for the transition to the next stage of monetary policy easing will be formed. In this case, the main factor influencing the ECB’s decisions will be data on the condition of the European economy. Dean Turner also said that against the background of the ongoing disinflation process, the mentioned financial regulator, like other central banks, can be confident enough to cut interest rates every three months.
In a statement released on Thursday, the ECB noted that progress has been made in the fight against inflation in recent quarters. At the same time, attention was drawn to the fact that domestic price pressure remains strong. The ECB explains this state of affairs by accelerating wage growth. The European financial regulator, as above mentioned, expects inflation to be above the 2% target over the next year.
The opinion is also currently circulating in the expert community that the biggest risk to the prospects for subsequent monetary policy easing in the EU lies in the actions of the Fed, not in the dynamics of wages or inflation rates. The central bank of the United States, without any double entendres or ambiguous formulations, stated that there were no intentions related to cutting interest rates in the foreseeable future. In any case, the ECB will have to take this position of the Fed into account in its activities. The significant difference in the cost of borrowing on both sides of the Atlantic Ocean generates risks for the EU such as a weakening of the euro and an increase in imported inflation.
It is worth noting that the Bank of England, according to the opinion spread in the expert community, will also not make quick decisions and take quick actions in the foreseeable future regarding easing monetary policy. Elections will be held in the United Kingdom in July. This political process is not a kind of background reality in the context of which the Bank of England should decide on cutting interest rates. The next meeting of the financial regulator of the United Kingdom will be held on June 20.
Mark Wall, chief European economist at Deutsche Bank, says the tone of the ECB’s statements is hawkish, despite the decision to cut interest rates. The expert stated that the European financial regulator is not an organization that seeks to soften its monetary policy strategy as quickly as possible.
It is also worth mentioning that last year the EU economic system miraculously avoided the materialization of a recession scenario. The current state of affairs is more optimistic, both in the context of the situation observed in the present and in terms of the prospects of the future. Nowadays, the EU economy is showing signs of recovery. This tendency could potentially prop up inflation.
In May, the EU combined output in manufacturing and services hit a 12-month high. The corresponding result was recorded following the results of a survey of purchasing managers compiled by S&P Global and Hamburg Commercial Bank. At the same time, business confidence in the EU reached its highest level in more than two years in May. Unemployment in this region is currently at a record low.
Also on Thursday, the ECB published an improved forecast for the growth of the European economy in the current year. The financial regulator expects that the corresponding indicator for 2024 will be fixed at 0.9%. The previous version of the mentioned forecast provided that economic growth in the EU in the current year would be 0.6%.
Returning to the issue of high interest rates, it should be noted that such indicators tend to contribute to gaining more international capital flows into a country and stimulate demand for its currency.
As we have reported earlier, Fed’s Neel Kashkari Needs More Months’ of Positive Inflation Data Before Rate Cut.
