【MACRO Insight】The European Central Bank (ECB) adjusts monetary policy with an interest rate cut, but does not commit to a specific rate path!?

Amid ongoing inflationary pressures in the Eurozone, the ECB announced a 25 basis point interest rate cut at 20:15 Beijing time on Thursday, marking the first rate cut since 2019. After the cut, the three key interest rates were adjusted to 4.25%, 3.75%, and 4.50% respectively, making the ECB the second central bank in the G7 countries to cut rates after the United States.

In its latest policy decision, the European Central Bank (ECB) announced a reduction of 25 basis points in all three main interest rates, an adjustment made after an in-depth assessment of the current inflation outlook, potential inflation dynamics, and the effectiveness of monetary policy transmission. Since September 2023, the inflation rate has fallen by more than 2.5 percentage points, indicating some alleviation of inflationary pressures. Nevertheless, due to ongoing wage growth and domestic price pressures, it is expected that the inflation rate will remain above the target level next year.

However, the ECB also emphasized that it will not pre-set a specific interest rate path and will make decisions based on economic data and inflation conditions at each meeting. Since September 2023, the inflation rate has fallen by more than 2.5 percentage points, but it is still expected to be above the target next year. ECB President Christine Lagarde stated at a press conference that, despite recent progress in combating inflation, she maintains a cautious attitude towards the future decline of inflation. After the ECB's interest rate decision was announced, the euro rose sharply against the US dollar, recovering all intraday losses and reaching 1.09. The money market had already fully digested the central bank's expectation of a 25 basis point rate cut at the June meeting.

To ensure that the inflation rate can return to the 2% medium-term target in a timely manner, the ECB stated that it will maintain restrictions on policy interest rates and decide on appropriate policy measures at each meeting based on the inflation outlook, economic and financial data, potential inflation dynamics, and the strength of monetary policy transmission. At the same time, the Governing Council also confirmed that it will reduce the securities held under the Pandemic Emergency Purchase Programme (PEPP) in the second half of this year, with an average monthly reduction of 7.5 billion euros, and plans to stop reinvestment under PEPP by the end of 2024.

Furthermore, the ECB will continue to fully reinvest the principal of maturing securities purchased under the PEPP until the end of June 2024, and flexibly use the redemption of the PEPP portfolio for reinvestment to address the risks associated with the monetary policy transmission mechanism due to the pandemic. At the same time, the Governing Council will regularly assess the impact of targeted lending operations and their continuous repayments on the monetary policy stance, and is prepared to adjust all tools to ensure the achievement of the inflation target and the smooth transmission of monetary policy.

According to the latest forecasts, the overall inflation rate for 2024 is expected to be 2.5%, 2.2% for 2025, and is projected to drop to 1.9% by 2026. For core inflation (excluding energy and food prices), it is expected to be 2.8% in 2024, 2.2% in 2025, and further reduced to 2.0% by 2026. In terms of economic growth, it is expected to rebound to 0.9% in 2024, increase to 1.4% in 2025, and is projected to reach 1.6% by 2026.

The market's reaction to the prospect of interest rate cuts shows that the ECB's interest rate is expected to be lowered by 59 basis points within the year, with uncertainty about the speed and timing of the cuts. Analysts generally believe that although the ECB has taken its first interest rate cut since 2019, its statement shows a hawkish inclination, and the pace of future easing policies is not certain. In addition, analysts point out that the ECB's rate cut while raising inflation expectations may trigger discussions about policy mistakes. Nevertheless, the market expects that the ECB may pause during the rate-cutting process to limit policy divergence with the Federal Reserve.

Inside sources have revealed that despite the interest rate cut this week, European Central Bank (ECB) officials have almost ruled out the possibility of another rate cut in July and have not reached a consensus on whether to cut rates in September. Policymakers have raised their inflation expectations, but opinions on the future path of interest rates are divided. Carsten Brzeski from ING Bank believes that the ECB is shifting towards forward-looking forecasts rather than relying on historical data, which signifies its efforts to become a more forward-looking central bank.

However, some conservative policymakers regret the clear signal of an interest rate cut, believing that without previous commitments, they might have chosen not to cut rates in June. The Governor of the Austrian Central Bank, Robert Holzmann, opposed the rate cut in June, emphasizing that decisions should be data-driven. ECB President Christine Lagarde emphasized that the ECB will rely on data, assess interest rates at each meeting, and maintains a cautious attitude towards whether to enter a rate-cutting cycle.

In the meantime, the Bank of Canada has also taken measures to cut interest rates, while the market expects the Federal Reserve and the Bank of England to keep interest rates unchanged. Lagarde emphasized that the ECB's policy decisions will depend on data, not the actions of other central banks.