The European Central Bank cut interest rates as expected yesterday but hinted at a pause in its year-long easing cycle after inflation finally returned to its 2 per cent target.
The ECB has lowered borrowing costs eight times, or by 2 percentage points, since last June, seeking to prop up a euro zone economy that was struggling even before erratic US economic and trade policies dealt it further blows.
With inflation now just below 2pc, ECB President Christine Lagarde said the central bank for the 20 countries that share the euro was in a “good position”, which investors took as signalling a break in cuts, if not an end to policy easing.
“We are well-positioned after that 25 basis point rate cut and with the rate path as it is,” Lagarde told a Press conference. “With today’s cut, at the current level of interest rates, we believe we are in a good position.”
The interest rate path implied by markets sees a pause in July and anticipates just one more cut in the deposit rate toward the end of the year, possibly in December.
“I think we are getting to the end of a monetary policy cycle that was responding to compounded shocks, including Covid, including the war in Ukraine, the illegitimate war in Ukraine, and the energy crisis,” Lagarde said.
Economists also saw her words as a clear indication of a pause and some even bet that the ECB’s most aggressive easing cycle since the global financial crisis of 2008-2009 might be at a close.
“We think the ECB is done cutting rates now, but this view is contingent on no major negative surprises surfacing and economic outlook to gradually become more robust in line with the ECB’s forecasts,” Nordea said in a note to clients.
Lagarde said the decision yesterday was virtually unanimous, with only one policymaker objecting to a cut.
“Our central view is that today’s cut is likely the last for some time,” HSBC said in a note.
Lagarde also said the euro zone appeared to be attracting more foreign investment, a sign of growing investor confidence and part of the reason why the euro has firmed so much since the US administration embarked on its global trade war.
But there is exceptional uncertainty in the outlook.
Falling energy prices and a stronger euro could put further downward pressure on inflation, said Lagarde, adding that effect could be reinforced if higher tariffs led to lower demand for euro exports and re-routing of overcapacity to Europe.
Depending on the outcome of the trade war with the United States, inflation and growth could significantly differ from projections, the ECB said, as it took the unusual step of releasing alternative scenarios to its forecasts.
The case for a pause rests on the premise that the short- and medium-term prospects for the currency bloc differ greatly and may require different policy responses.
Inflation is set to dip in the short term and undershoot the ECB’s target next year, but increased government spending and higher trade barriers will add to price pressures later.
The added complication is that monetary policy impacts the economy with a 12-to-18 month lag, so support approved now could be giving help to a bloc that no longer needs it.
“In our baseline, we expect the ECB to pause at the July meeting and deliver a final rate cut in September,” PIMCO portfolio manager Konstantin Veit said. “A more recessionary configuration will likely be needed for the ECB to go faster and further in this cutting cycle.”
Acknowledging near-term weakness, the ECB cut its inflation projection for next year.
US President Donald Trump’s tariffs are already damaging activity and will have a lasting impact even if an amicable resolution is found, given the hit to confidence and investment.
Most economists think inflation could fall below the ECB’s 2pc target next year, triggering memories of the pre-pandemic decade when price growth persistently undershot 2pc, even if projections show it back at target in 2027.
Further ahead, the outlook changes significantly.
The European Union is likely to retaliate against any permanent US tariffs, raising the cost of trade. Firms could relocate some activity to avoid trade barriers but changes to corporate value chains are also likely to raise costs.
Higher European defence spending, particularly by Germany, and the cost of the green transition could add to inflation while a shrinking workforce due to an ageing population will keep wage pressures elevated.
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