European Central Bank (ECB) President Christine Lagarde speaks at a press conference after the ECB Governing Council meeting in Frankfurt am Main, western Germany, April 11, 2024.
Kirill Kudryavtsev | Kirill Kudryavtsev AFP | Getty Images
FRANKFURT – The European Central Bank will cut euro zone borrowing costs this week for the first time since September 2019.
It would mark the official end of the record-breaking cycle of rapid gains that began as inflation surged in the wake of the Covid-19 pandemic. But investors’ attention appears to be shifting to what will happen if the Frankfurt agency cuts interest rates this June.
“Judging from officials’ comments, there is no doubt about the wisdom of cutting interest rates on June 6,” said Mark Wall, ECB observer at Deutsche Bank.
“Even if HICP (Coordinated Index of Consumer Prices) unexpectedly rises in May, the ECB can still argue that cutting interest rates is consistent with its reaction function. The question is, what happens after June?”
The inflation rate in the Eurozone in May was slightly higher than expected, with the overall inflation rate of 2.6% and the core inflation rate of 2.9%. On top of that, negotiated wage growth (a figure closely watched by the ECB) did reaccelerate to 4.7% in the first quarter after reaching 4.5% in the fourth quarter of 2023.
“A lot of this data is distorted by one-off effects,” said Holger Schmieding, chief economist at Berenberg.
“For example, a mild winter boosted outdoor construction in the first quarter, thereby boosting real GDP growth, while one-time payments in some countries such as Germany at the start of the year kept wages higher than usual.”
However, while another rate cut in July cannot be ruled out, it seems unlikely given recent comments from ECB policymakers.
Isabel Schnabel, a member of the Board of Directors of the European Central Bank, said in an interview with German public broadcaster ARD on May 16: “We find that some elements of inflation are persisting, especially domestic inflation, especially services. Industry. ”
“I would caution against moving too quickly because there is a risk of cutting interest rates too quickly. We should absolutely avoid that,” she said.
The next step on this bumpy road will be a divergence between the ECB and the Fed’s own rate settings, which looks more like a “longer move higher.” This is no easy task as it could have a significant impact on the euro-dollar exchange rate, which drives up inflation through the price of imported goods and services.
“In 6 to 12 months, under our assumptions, the policy spread between the Fed and the ECB will rise to historically high levels, if domestic demand strengthens as expected, margin bands are narrower, and policy rates are less constrained. ,” Mark Wall explained.
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