The European Central Bank has eased pressure on borrowers across the eurozone as it cut its key interest rate for the first time in almost five years.
Citing a steady decline in inflation, the ECB said its deposit rate would be cut to 3.75% from a record 4%, putting it ahead of the US Federal Reserve and the Bank of England, which have yet to have reduced interest rates.
Financial markets eagerly awaited the eurozone’s first rate cut since September 2019, which will also affect the ECB’s main refinancing operations rate, which fell from 4.5% to 4.25%.
City analysts had forecast lower borrowing costs at the ECB’s June meeting after signals the central bank was poised to offer more support to eurozone economies following a period of economic stagnation following Russia’s invasion of Ukraine.
In a statement, the ECB said: “Keeping interest rates high for nine months has helped reduce inflation. It is now appropriate to ease the degree of monetary policy constraint.”
ECB President Christine Lagarde said the central bank was confident its forecasts were strong and if inflation continued its long-term downward trajectory, interest rates would continue to fall.
She said: “It is on the basis of the reliability, consistency, consistency and strength of our forecasts that we have made the decision to cut.”
Lagarde said wage settlements were moderate and companies were absorbing some of the increase in labor costs rather than passing them on to consumers, reducing inflationary pressures.
However, she added that there are still risks to the outlook for inflation, saying: “Despite progress over recent quarters, domestic price pressures remain strong as wage growth has picked up and inflation is likely to remain above target well into the year future”.
Dean Turner, chief eurozone economist at UBS Global Wealth Management, said the outlook for inflation, as indicated by the ECB’s latest forecasts, point to further interest rate cuts later this year.
Turner said: “Of course, the timing of the ECB’s next move is uncertain, as it will depend on incoming data. But with the disinflation process underway, the ECB, along with other central banks, should feel confident enough to ease policy, most likely at a pace of one cut per quarter.”
However, the ECB expects inflation to be slightly higher this year and in 2025 than it forecast in March. It said inflation would average 2.5% in 2024 and 2.2% in 2025, down from its previous forecast of 2.3% and 2% respectively.
Mark Wall, chief European economist at Deutsche Bank, said the higher-than-expected inflation numbers would make ECB policymakers more cautious about future cuts.
Financial markets expect just one further cut this year and three next year, knocking a further percentage point off eurozone interest rates by the end of 2025.
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Wall said: “The statement gave less guidance than might be expected about what comes next. In that sense, the immediate tone is a ‘hawkish cut’. This is not a central bank rushing to ease policy. “
Tensions with the eurozone are expected to emerge as economies recover from the pandemic and the initial impact of the war in Ukraine at varying speeds. Croatia, which recently joined the euro, and Romania are among the countries expected to grow by more than 3% this year, according to the European Commission, with inflation running at 3.5% and 5.9% respectively.
The commission’s projections show that the economies of France and the Netherlands will expand by less than 1% this year with an inflation rate of 2.5% in both countries.
Lagarde said the ECB was aware of variations across the currency bloc, but it was the central bank’s job to set interest rates based on average growth and inflation rates.
Economic growth across the eurozone is expected to improve following better-than-expected performances in Germany, Italy and Spain.
The average growth rate for the eurozone would be 0.9% in 2024, 1.4% in 2025 and 1.6% in 2026, the ECB said.