FRANKFURT, GERMANY – The European Central Bank is preparing to lower borrowing costs for the eurozone for the first time since 2019. This decision comes as the bank concludes its fast-paced cycle of hiking rates that was initiated in response to the Covid-19 pandemic and subsequent rise in inflation. While this move is anticipated, investors are already looking ahead to what the future holds post-June cut by the ECB.
According to Mark Wall, an ECB watcher with Deutsche Bank, officials have shown no hesitation in the decision to cut rates in June. Despite May’s HICP data showing slight inflation increases, the ECB maintains that a rate cut remains aligned with its reaction function. The focus now shifts to what lies beyond the upcoming cut in borrowing costs.
In May, the eurozone saw inflation figures higher than expected, with headline inflation at 2.6% and core inflation at 2.9%. Additionally, negotiated wage growth in the region accelerated to 4.7% in the first quarter, compared to 4.5% in the previous quarter of 2023. However, Berenberg’s chief economist Holger Schmieding notes that these numbers may be distorted by one-off effects, such as mild weather and one-time payments.
Although the possibility of a rate cut in July remains, recent communications from ECB policymakers suggest it is not highly probable. ECB board member Isabel Schnabel warns against a rush to lower interest rates too quickly, citing the risk of doing so. The disparity between the ECB and the U.S. Federal Reserve’s rate-setting policies may pose challenges, particularly regarding the euro-dollar exchange rate and its impact on inflation through imported goods and services.
Looking ahead, market analysts predict that a notable divergence in policy rates between the Fed and ECB may lead to significant implications, including a potential increase in inflation driven by FX depreciation. It is crucial for central banks to navigate these complexities carefully to ensure stability in economic conditions moving forward.