After experiencing the most severe inflation surge and interest rate cycle in decades, the European Central Bank (ECB) is almost certain to be one of the first major central banks to lower interest rates. The ECB’s Chief Economist has already issued a clear signal that a rate cut is imminent next week.
The ECB is set to hold a meeting next Thursday, June 6th.
On Monday, May 27th, the ECB’s Chief Economist Philip Lane, in an interview with the Financial Times, stated, “Unless there is a major unexpected event, the current situation we are seeing is sufficient to dispel the highest level of constraints.”
The inflation rate in the Eurozone has approached the ECB’s target of 2%. Investors are betting that at the upcoming meeting, the ECB will lower the benchmark deposit rate from its historical high of 4% by 0.25%.
Central banks in Switzerland, Sweden, the Czech Republic, and Hungary have already lowered rates this year to combat declining inflation. However, in the world’s major economies, the Federal Reserve and the Bank of England are not expected to cut rates before summer, while the Bank of Japan is considered more likely to continue raising rates.
Lane added that a key reason for the Eurozone’s faster decline in inflation compared to the United States is the greater impact of the Russia-Ukraine conflict in the region. He said, “Dealing with the war and energy issues has come at a high cost for Europe.”
“But in terms of starting rate cuts, this indicates that monetary policy has been effective in ensuring timely inflation moderation. In that respect, I believe we have been successful,” he said.
However, the ECB is expected to maintain rates within a restrictive range this year to ensure sustained cooling of inflation. Lane cautioned that eliminating inflation “will be a very tricky issue.”
Lane stated that the pace of rate cuts by the ECB this year will depend on data, lowering rates within the restrictive range, and ensuring proportionality and safety.
Lane is responsible for drafting and submitting proposed rate decisions, which are then decided upon by the 26 members of the Governing Council.
Recent data shows that wage growth in the Eurozone rebounded to near record speed at the beginning of this year, but Lane stated, “The overall direction of wages still points to a slowdown, which is crucial.”
He further noted that data tracking wages at the ECB also supports this.
Some analysts warn that if the ECB aggressively cuts rates and diverges from the Fed’s rate policy, it could lead to a depreciation of the euro, raising import prices and thus increasing inflation.
Lane stated that the ECB would consider any “significant” exchange rate fluctuations, but there are currently no indications in that direction.
The current inflation rate in the Eurozone has dropped from over 10% in 2022 to a near three-year low of 2.4% in April. However, it is expected that the data for May, to be released this week, will rise to 2.5%.
Lane mentioned that rapid wage growth has pushed up service prices, keeping cost pressures high, meaning the ECB will have to maintain a restrictive policy until 2025.