The European Central Bank held interest rates at a record high as expected on Thursday but signalled it may soon start to cut them, even as investors question whether stubborn U.S. inflation will stop the Federal Reserve from following close behind.
The ECB has kept borrowing costs steady since September but has long signalled cuts were coming into view, with policymakers awaiting a few more comforting wage indicators to accompany benign inflation figures before pulling the trigger.
Despite Wednesday’s hotter-than-expected U.S. inflation print, the ECB underlined that message with new wording in its regular statement on policymakers’ deliberations.
“If the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission were to further increase its confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction,” the ECB said.
In her press conference, ECB President Christine Lagarde acknowledged the relevance of developments in the U.S. economy – the world’s largest – to its policy-setting but also stressed that conditions in the euro zone were different.
“I don’t think you can draw conclusions … based on the assumption that the two inflations (euro zone and U.S.) are the same. They are not the same,” she said.
“We are data-dependent, not Fed-dependent,” Lagarde added.
Lagarde said that “just a few” members of the Governing Council believed it was already time to loosen policy but had rallied to the consensus to wait. She said the central bank for the 20 countries that share the euro would have more information and issue new inflation and growth projections in June.
Earlier, the ECB said incoming information broadly confirmed its previous inflation assessment, while wage growth was moderating and firms were absorbing more of the labour cost increases via their profit margins.
Nevertheless, domestic price pressures were strong and keeping services price inflation high, it noted.
Analysts believe the biggest complication could be if the Federal Reserve delays its own policy easing to maintain the battle against inflation. The U.S. central bank generally sets the tone for global financial markets.
“Bumps in the road”
After the ECB decision, money markets priced around a 70 per cent chance of a 25 basis point rate cut in June, compared to a roughly 80 per cent chance earlier on Thursday.
Lagarde stressed it was “not pre-committing to a particular rate path”. While some analysts said the ECB had given itself some wiggle-room to hold in June if need be, they added the bigger question was the pace of future cuts.
“The ECB will keep a close eye on the Fed. If the Fed doesn’t cut this year, that limits the scope for ECB cuts to perhaps two,” said Arne Petimezas at Amsterdam-based AFS Group.
The eurozone is now in its sixth straight quarter of economic stagnation and the labour market is starting to soften.
The US economy, on the other hand, continues to grow above trend, its labour market remains tight and inflation rose more than expected last month, raising the risk of price growth getting stuck.
Markets have been pricing in 75 basis points of ECB interest rate cuts this year, or two moves beyond June, which could come in September and December, when the ECB also publishes new staff economic projections.
Supporting that prediction, consumer price inflation fell to 2.4 per cent last month and could ease back to the ECB’s 2 per cent target before year-end, ahead of the bank’s own 2025 projection.
Meanwhile rapid wage growth, seen by the ECB as the single biggest inflation threat, is slowing, labour markets are softening, investment is weak and bank lending stagnant – all pointing to a further decline in price pressures.
This outlook is in stark contrast to the United States, where rate cuts have been priced out in recent weeks given robust labour market data and stubborn price pressures.
Lagarde said the bank was keeping a close watch on oil futures after Middle East tensions pushed prices to six-month highs of around $90 a barrel but reaffirmed a forecast that euro inflation would return to a 2 per cent target by middle of next year.
“We will have those bumps in the road, if you will, but we’re reaching the target in mid-’25,” she said. “But bumps will be there. It will not be linear.”