Despite falling inflation, the European Central Bank (ECB) is expected to keep interest rates unchanged at next week’s policy meeting on April 11. Governing council members have previously cited the need to evaluate fresh wage data, due in May, before making the decision to lower rates.
The council will meet again on June 6, a week before the US Federal Reserve will decide on rates (June 12) and two weeks ahead of the Bank of England’s (BoE) and Swiss National Bank’s (SNB) meetings, both on June 20.
Since September 2023, the ECB has kept its key interest rate – known as the main refinancing operations rate or MRO – at a record high of 4.5%.
Stock and Bond Markets Expect a June Rate Cut
Money markets are anticipating a first rate cut of 25 basis points in June, with three more rate reductions priced in to follow by the end of 2024. A recent Reuters poll showed that roughly 90% of economists surveyed expect the first interest rate cut in June.
“Inflation has fallen materially, and is now within touching distance of central banks' targeted levels. Meaning, soon there will be no reason not to cut interest rates, if indeed inflation is under control,” said Morningstar’s European market strategist Michael Field.
ECB council members have also done their part to fuel that expectation. The governor of Spain’s central bank Pablo Hernandez de Cos told Bloomberg earlier this week that his “central scenario is that June could actually be the first reduction”. The governor of France’s central bank, Francois Villeroy de Galhau, echoed the sentiment, saying the bank will start with a "moderate" interest rate cut this spring, Reuters reports.
Will ECB Council Members Delay Too?
Meanwhile on the other side of the Atlantic, the chairman of the US Federal Reserve (Fed) Jerome Powell said on Wednesday that stubbornly high inflation may keep the US central bank from the anticipated June rate cut.
This has raised some questions in Europe if the ECB will go ahead with its own rate decision. The Frankfurt-based bank has historically been hesitant to make monetary decisions ahead of its American counterpart, and it was also be one of the last major central banks to embark on the recent hike cycle.
Several council members, including ECB president Christine Lagarde, have tried to dismiss any such considerations, saying that what counts for the ECB are its own inflation and economic forecasts. And the head of the Finnish central bank Olli Rehn stressed: “The ECB is not the Fed's 13th Federal District”.
His colleague and head of Austria’s central bank Robert Holzmann, who is considered one of the more hawkish members of the council, told Austrian newspaper Kronen Zeitung that the European economy was growing more slowly than its US counterpart and therefore, Europe could cut interest rates before the US.
"From today's perspective, I would say: interest rate cuts are likely to come. When will depend largely on what wage and price developments look like by June," he said. The lower wage agreements in Europe were, the more scope there would be to reduce borrowing costs, Holzmann told Reuters.
However, he also warned that the ECB should be careful in pushing down rates alone. If the Fed does not cut rates in June, the market reaction to the policy divergence would negate much of the benefit of an ECB cut, he said in a recent interview with Reuters.
If the ECB cuts key interest rates earlier and lower than the Fed, the interest rate gap between the USA and the eurozone will widen. This will inevitably have an impact on exchange rates, capital flows and inflation. Investors are therefore finding it difficult to buy the ECB's claims of independence.
Eurozone Inflation Falling, Markets Rising
Inflation in the eurozone fell to 2.4% year on year in March, down from 2.6% in February, Eurostat said on Wednesday. Economists had been expecting a flat reading month on month, so the numbers came a positive surprise. “With inflation now within spitting distance of the ECB’s 2% targeted level, investors will be even more convinced that interest rate cuts are on the near-term horizon,” said Michael Field. Core inflation, which shows prices without energy and food costs, also fell to 2.9% year on year. It was at 3.1% in February.
He adds that in many ways the European economy sits in "Goldilocks" territory, ie not too hot and not too cold. “It's weak enough that the central banks should not be concerned about overheating it by cutting rates. At the same time, it still has some life left in it, judging by recent data points showing upticks in mortgage lending and service-industry activity. Meaning, that stimulus here, in the form of rate cuts, could effectively kindle economic growth.”
This is not to say that Europe is bouncing back yet; there is a lag effect. “Even if central banks soon implement interest-rate cuts, they will take some time to feed through to the economy, with the ECB forecasting just 0.6% growth in 2024.”
Recent rallies on equity markets have not been led by a blowout earnings season or improved guidance from companies, he adds. “Objectively, though, we are drawing ever closer to interest-rate cuts, which will certainly stimulate the European economy.”
Meaning, soon there will be no reason not to cut interest rates, if indeed inflation is under control. In a surprise move on March 21, the Swiss National Bank (SNB) was the first major bank to cut rates.
Will the ECB Cut Rates? This is What Economists Think
We rounded up some expert commentary on the anticipated impact of rate cuts on markets.
Matthew Ryan, Head of Market Strategy at Ebury
The disinflationary process continues to gather pace in the Euro Area, which will be very welcome news indeed for European Central Bank officials. Not only did the main inflation measure ease to its lowest level in nearly three years, but the more sticky core number also dropped to a two-year low below 3%, both less than expectations. This should provide policymakers with confidence that their actions are continuing to bear fruit, and that a loosening in monetary policy will soon be warranted. We now see a June interest rate cut from the ECB as a near certainty - indeed this is currently fully priced in by market participants.
Tiffany Wilding, Economist, and Andrew Balls, CIO Global Fixed Income, Pimco
In the eurozone, we see expectations for the ECB and the level of 10-year yields as broadly fair versus the US in our baseline economic scenario. Yet we see the balance of risks as leaning toward weaker economic performance and more easing from the ECB. We also prefer the US dollar over the euro and other European currencies such as the Swiss franc and the Swedish krona, anticipating further U.S. economic exceptionalism.
Robin Winkler, Chief Economist for Germany, Deutsche Bank Research:
The spectre of inflation continues to fade. As in other European countries, the inflation rate in Germany fell more sharply than expected in March. At "only" 2.2%, the inflation rate is well on the way to falling below the important 2% mark, at least temporarily, by early summer at the latest. The core inflation rate also fell to 3.3% in March. This means that inflation remains high. However, the positive trend in both Germany and the rest of the eurozone should encourage the ECB in its intention to initiate a turnaround in interest rates in June.
Jan Viebig, Chief Investment Officer, ODDO BHF SE
We are currently assuming that the ECB could start to cut key interest rates in summer 2024. What is important for investors is not the month in which the central bank introduces interest rate cuts, but that a fall in interest rates of probably 50 to 100 basis points is very likely this year. Anyone currently investing money in the bond market in the short term will probably only be able to reinvest their capital at lower interest rates in the future. We have therefore increased the maturity of the bonds in our portfolios. Short-term investments in fixed-term deposits are currently associated with a reinvestment risk. It is worth thinking about longer-term investments.
