ECB cuts interest rates as fight against inflation reaches turning point

The European Central Bank on Thursday cut interest rates for the first time in five years, a sign of significant progress in the global fight to rein in the highest inflation since the early 1980s.

The ECB, as expected, became the first major central bank to reduce borrowing costs, cutting its policy rates by a quarter of a percentage point. Annual inflation in May was 2.6 percent, down from a peak of 10.6 percent in October 2022.

The ECB’s governing council, the bank’s rate-setting body, said it was “appropriate” to cut rates as price pressures were gradually easing.

The move came even as ECB officials raised their inflation forecast and warned that wages were rising at a “high” rate. Prices are now expected to rise this year at an annual rate of 2.5 percent, compared with a March forecast of 2.3 percent.

But months of steady progress convinced policymakers that a modest reduction in borrowing costs was warranted, ECB President Christine Lagarde said in Frankfurt. Much of the rise in euro zone wages represents labor contracts aimed at offsetting recent years of rapid price rises, rather than a continuing trend, she said.

Even after today’s action, interest rates will continue to be a drag on the economy. The ECB’s governing council promised to bring annual inflation back to 2 percent “in a timely manner.” Lagarde reiterated her stance that European authorities will decide future rate moves at each of their scheduled meetings based on the latest economic data.

New shocks from wars in Ukraine and the Middle East could shake energy and freight markets, disrupting expectations of a gradual improvement in prices.

“We know the road will be full of obstacles,” he told reporters.

Bank officials said they have also become slightly more optimistic about growth prospects. This year, the euro zone economy is projected to expand at an annual rate of 0.9 percent, up from a March forecast of 0.6 percent.

There was little immediate reaction in financial markets to the ECB’s move, which Lagarde had telegraphed for months. The value of the euro barely changed, hovering around $1.09.

“It is always significant when the first major central bank starts cutting rates. We’ve seen it in some of the smaller emerging markets, but it’s kind of a milestone when one of the big ones moves,” said Eric Winograd, director of developed markets economic research at AllianceBernstein. “It’s a harbinger of what we expect from other central banks.”

In fact, investors remain eager for the Federal Reserve to join the parade. Going into the year, markets expected the Fed to lower rates seven times in 2024. But inflation, while down significantly from its mid-2022 peak, remains above the Fed’s 2 percent target. for price stability.

Almost no one expects the Federal Reserve to make cuts when its policy-making committee meets on June 12. But there is a 70 percent chance the Federal Reserve will cut in September, according to CME FedWatch, which tracks investor bets in the futures market.

European interest rates have followed an extraordinary trajectory over the last decade. Amid chronic economic weakness, the ECB cut its benchmark rate into negative territory in 2014 and kept it there until the post-pandemic inflation surge. European monetary authorities then raised rates nine times, eventually reaching a record 4 percent in September.

Europe’s inflation problem in recent years was largely due to rising energy prices following Russia’s invasion of Ukraine. Those costs have decreased. But growth in the 20-nation euro zone has lagged. Since the beginning of 2022, the size of the US economy has grown 4.7 percent compared to just 1.7 percent in Europe, according to TD Securities.

ECB officials are likely to pause before implementing additional rate cuts, according to Jacob Kirkegaard, an economist at the Peterson Institute for International Economics.

“They will wait and see: possibly it will be reduced in September, possibly it will be reduced three times in 2024,” he said.

The ECB’s action came a day after the Bank of Canada became the first member of the Group of 7 democracies to lower rates. In its first cut since 2020, the Canadian central bank reduced its policy rate by a quarter of a percentage point, to 4.75 per cent.

“We’ve come a long way in fighting inflation,” said Tiff Macklem, governor of the Bank of Canada.

Further rate cuts are likely if inflation continues to decline. But progress in eradicating inflation is likely to be “uneven,” Macklem said.

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