The European Central Bank (ECB) is set to reduce interest rates from their record highs on Thursday, marking its first rate cut since 2019. This decision comes as the ECB acknowledges progress in its battle against high inflation, which has dropped from over 10% in late 2022 to just above the 2% target in recent months across the 20 eurozone countries. However, ECB President Christine Lagarde and her colleagues are expected to stress that the fight against inflation is far from over, particularly with persistent price pressures in the services sector.
ECB policymakers have signaled their intention to lower borrowing costs after witnessing a significant decline in inflation. The steep rate hikes, initiated in response to soaring prices following Russia's invasion of Ukraine, are now being reevaluated as the ECB joins other central banks, including those in Canada, Sweden, and Switzerland, in cutting rates.
Despite the anticipated rate cut, the ECB is unlikely to commit to further reductions in the near term. Instead, the central bank will emphasize that any additional moves will depend on incoming economic data, ensuring that borrowing costs remain sufficiently high to curb inflation. Fabio Balboni, an economist at HSBC, noted, "Further cuts in September and December remain our central case. But if the recent resilience in services inflation proves sustained, we see increasing chances that the ECB might have to be more cautious on the way down."
All 82 economists polled by Reuters expect the ECB to trim its deposit rate to 3.75% from a record 4.0%. However, not all experts agree with this move. Gabriele Foà, a portfolio manager at Algebris Investments, described the cut as potentially "a policy mistake," while JPMorgan economist Greg Fuzesi called it "oddly rushed."
Philip Lane, ECB's chief economist, recently set the tone by stating that a rate cut would not be a "declaration of victory," and further reductions would depend on progress in domestic inflation and demand. Most economists still anticipate two additional cuts by the end of the year, though market expectations have become more cautious.
Recent data has fueled concerns about the "last mile" of reaching the ECB's 2% inflation target. Eurozone inflation rose more than expected in May, particularly in the services sector, which rebounded to 4.1% from 3.7%. This increase is likely linked to larger-than-expected wage hikes in the first quarter of the year, boosting consumers' disposable income after years of below-inflation pay rises.
The ECB's decision is also influenced by the Federal Reserve's cautious approach to its easing cycle. Mohit Kumar, an economist at Jefferies, suggested, "The pace of rate cuts will be dependent on the U.S. and the Fed. In the event that the Fed doesn't cut rates at all this year - not our base case - we could see only two cuts from the ECB this year."
Amid these developments, global tech shares have surged, with Nvidia Corp. set to build on its $3 trillion market capitalization, driven by expectations of interest rate cuts and ongoing enthusiasm for artificial intelligence. European stocks reached a new all-time high ahead of the ECB meeting, and U.S. equity futures remained steady.
"The earnings are there, companies have been delivering on earnings," said Guy Miller, chief strategist at Zurich Insurance Company Ltd. "Nvidia is a classic example. It seems extremely expensive but goes on not only meeting, but beating expectations."
Bond yields across Europe have ticked higher as traders await guidance from ECB President Christine Lagarde on the path for additional easing. Treasury yields in the U.S. also inched higher, with markets almost fully pricing in two Fed rate cuts in 2024.
The ECB's upcoming decisions will be closely watched, especially given recent stronger-than-anticipated economic growth and wage increases in the eurozone. New forecasts are expected to suggest inflation returning to the ECB's 2% goal next year, maintaining the central bank's course for more easing, barring any new inflation surprises.
Holger Schmieding, an economist at Berenberg, remarked, "If anything, the five quarters of stagnation in the eurozone economy from autumn 2022 to the end of 2023 suggest that the ECB may have overreacted with its rate hikes. Seen from this angle, somewhat lower rates make sense."
