Europe Central Bank China's central bank cut borrowing costs from historic highs on Thursday, acknowledging progress in curbing high inflation but also suggesting the battle was not yet won as inflation would remain too high until next year.
Inflation in the 20-nation euro zone has fallen from above 10% at the end of 2022 to just above the ECB’s 2% target in recent months, thanks largely to lower fuel costs and a return to normalisation of supply after some post-pandemic hurdles.
But that progress has stalled recently, with what appeared to be a massive easing cycle by the ECB a few weeks ago now looking more uncertain amid signs that eurozone inflation could be struggling like it has in the United States.
The ECB welcomed the fall in price gains and cut its deposit rate to 3.75% from a record 4.0%, the first cut since 2019.
But the central bank also raised its inflation forecasts for this year and next, stressed that further rate cuts would depend on incoming data, and reiterated that borrowing costs needed to remain high enough to curb price increases.
“Despite the progress made in recent quarters, inflation is likely to remain above target next year as domestic price pressures remain firm amid stronger wage growth,” the ECB said.
Money market investors reduced their bets on rate cuts after the central bank announced them, and see only one rate cut for the rest of the year, with a small risk of another.
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ECB President Christine Lagarde is likely to be asked about the pace of further easing and whether a rate cut in July is still possible at a news conference starting at 12:45 GMT.
With Thursday’s move, the ECB joined the central banks of Canada, Sweden and Switzerland in halting the biggest rate hikes in recent history.
The Fed paused its rate hikes earlier this year amid stronger-than-expected inflation data and is widely expected to join the rate hikes after the summer.
But some stronger-than-expected data on euro zone inflation, wages and economic activity in the past few weeks has raised concerns that the ECB faces a tougher “last mile” on the road to its goals – a concern often expressed by influential ECB board member Isabel Schnabel.
Services inflation, considered by some policymakers to be particularly important because it reflects domestic demand, has become a particular concern after it rebounded to 4.1% in May from 3.7% a month earlier.
Most economists still expect the ECB to continue cutting its policy rate in the coming months, bringing it down to 2.50% by the end of 2025.
But they see only two more rate cuts this year, in September and December.
“Further rate cuts in September and December remain our main forecast. However, if the recent rebound in services inflation persists, we see an increasing likelihood that the ECB may have to be more cautious in its rate cuts,” HSBC economist Fabio Balboni said in a note.
The rebound in growth also undercuts the argument that high interest rates are holding back economic activity, reducing the urgency for the ECB to act.
The real question, however, may be the Federal Reserve and whether it will initiate or further delay its own easing cycle.
A more restrictive Fed would likely mean a weaker eurozone and higher imported inflation, but it would also raise yields in global bond markets – a double whammy whose net effect is hard to predict.
“The pace of rate cuts will depend on the U.S. and the Fed,” said Mohit Kumar, an economist at Jefferies. “If the Fed does not cut rates this year (which is not our base case), we may only see two rate cuts from the ECB this year.”
