Policymakers at the European Central Bank (ECB) have cut interest rates, citing lower inflation and slowing economic growth as factors behind their decision to loosen monetary settings.
The ECB’s governing council voted on Sept. 12 to lower the benchmark interest rate—known as the deposit facility rate—by 25 basis points, or a quarter of a percentage point.
“Based on our updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission, it is now appropriate to take another step in moderating the degree of monetary policy restriction,” ECB President Christine Lagarde and Vice President Luis de Guindos said in a joint statement.
“Based on the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission, it is now appropriate to take another step in moderating the degree of monetary policy restriction.”
The cut lowers the rate that the ECB pays on bank deposits from 3.75 percent to 3.5 percent, a level that is still generally considered restrictive, meaning it has a cooling effect on the economy.
It’s the ECB’s second rate cut in three months, and marks a gradual normalization of the ECB’s monetary policy after the worst bout of inflation in a generation forced it to hike borrowing costs to record highs last year.
Recent inflation data came in “broadly as expected,” the ECB said, with staff seeing the headline pace of inflation averaging 2.5 percent in 2024, before falling to 2.2 percent next year.
Domestic inflation remains “high” due to rising wages, though labor-cost pressures are easing, the Governing Council said in the statement. Financing conditions are still tight, leading to weak private consumption and investment, with economic growth remaining subdued.
The ECB projects that the eurozone economy will grow by 0.8 percent in 2024, increasing to 1.3 percent in 2025 and 1.5 percent in 2026. These figures represent a slight downward revision from previous forecasts, mainly due to weaker domestic demand in the near term.
While Thursday’s interest-rate reduction was widely expected, there is less certainty about where things go from here, in particular whether the ECB will deliver another cut at its next meeting in October.
The eurozone’s central bank said it is “not pre-committing to a particular rate path” but instead pledging to adopt a flexible, meeting-by-meeting approach, basing decisions on incoming economic data.
Part of the uncertainty around whether the ECB will cut rates again in October is the fact that inflation is expected to rise again in the latter part of 2024, partly because previous sharp energy price fills will drop out of the annual rates, the ECB said. Another factor dimming the prospect of more near-term rate cuts is the fact that the ECB expects core inflation, which excludes energy and food, to be higher than previously projected for both 2024 and 2025, mostly due to services inflation being higher than expected.
Analysts at ING believe the ECB will eventually cut rates at a quicker pace, but probably not until next year.
“Why not this year? Because currently, German wage negotiations and increasing selling price expectations still point to some stickiness of inflation,” Carsten Brzeski, global head of macro at ING Research, said in a note on Thursday following the ECB’s rate-cut announcement.
“And given that the ECB’s track record of predicting inflation on its way up is rather weak, the ECB will want to be entirely sure before engaging in more aggressive rate cuts.”
Brzeski added that, while the ECB has tended to underestimate the pace of inflation, it has also overestimated its economic growth projections, with incoming data on the economy likely to weigh in favor of accelerating the pace of further interest rate reductions.
“Given that the ECB’s forecasts have been structurally overestimating the timing and the strength of the eurozone economy, it only seems to be a matter of time before a bleaker growth outlook will translate into more aggressive rate cuts,” Brzeski wrote.
