ECB lowers interest rate, but future cuts may be limited

The European Central Bank cut its key interest rate by a quarter-point on Thursday, moving ahead of the US Federal Reserve as central banks around the world lean towards lowering borrowing costs — a shift with far-reaching consequences for home buyers, savers and investors.

The ECB cut its benchmark rate to 3.75 per cent from a record high of 4.0 per cent at a meeting of the bank’s 26-member rate-setting council in Frankfurt.

Speaking afterwards at a news conference, ECB President Christine Lagarde said inflation had eased enough for the central bank to start lowering rates.

But with annual inflation at 2.6 per cent in May and expected to remain above the ECB’s 2.0 per cent target into next year, Lagarde declined to indicate how fast or how deep any future rate cuts might be.

“We will keep policy rates sufficiently restrictive for as long as necessary,” she said. “We are not committing to a particular rate path.”

“Are we today moving into a dialling-back phase? I wouldn’t volunteer that,” she said.

Rate increases combat inflation by making it more expensive to borrow in order to buy goods, lowering demand and taking the pressure off prices. But high rates also hold back growth, which has been in short supply in the eurozone.

With inflation coming down but taking its time to reach levels central bankers like, the question now is, how soon, how fast and how deep future rate cuts from the Fed, the ECB and others will be.

Analysts say the ECB will likely leave rates unchanged when it next meets on July 18, while it awaits further confirmation that inflation is under control.

“Today’s cut doesn’t necessarily mark the start of an easing cycle,” said Carsten Brzeski, global head of macro at ING, the Dutch banking firm.

Though the annual inflation rate for May is well below a peak of 10.6 per cent in October 2022, the decline has slowed in recent months. Inflation even ticked up slightly from 2.4 per cent in April. Inflation in the services sectors, a broad category that includes everything from medical care and haircuts to hotels, restaurants and concert tickets, remains particularly elevated at 4.1 per cent.

The ECB’s move represents a switch from the onset of the inflation surge, when the Fed took the lead in tightening credit by raising rates starting in March 2022, sending mortgage costs higher but also boosting returns for savers with money in certificates of deposit or money market funds. The ECB started four months later.

Major central banks around the world now are leaning towards lowering interest rates. Central banks in smaller economies have already cut rates, including in Canada, Sweden, Switzerland, Hungary and the Czech Republic. The Bank of England’s policymakers are scheduled to meet on June 20, but it’s not clear whether the governing board will cut the rate from 5.25 per cent. Japan, an economic outlier among the world big economies, has started raising rates after years of below-zero rates and low inflation.

Lower rates can mean lower mortgage costs and credit card charges for consumers. Lower rates also can boost stock prices and the value of retirement accounts since they diminish returns on conservative alternatives such as certificates of deposit, and can mean stronger economic growth that will boost corporate earnings.

The ECB’s higher rates quashed a nine-year-long rally in eurozone home prices and slammed construction activity. Growth in economic output has hovered just above and below zero for more than a year before a modest upbeat surprise in the first three months of the year, when gross domestic product rose 0.3 per cent from the quarter before.

The inflation surge in Europe was unleashed first and foremost by Russia cutting off most natural gas supplies to the continent, and by logjams in supplies of raw materials and parts as the global economy rebounded from the COVID-19 pandemic. Although the eurozone was hit first and hardest by the Russian cut-off, the resulting energy price spike has now largely subsided after spiking to 10.6 per cent in October 2022.

The US Federal Reserve faces a very different economy, one in which inflation was fuelled less by the Russian energy shock than by government pandemic recovery spending, and more robust growth fuelled inflation. The US consumer price index is at an annual 3.4 per cent, some way from the Fed’s goal, also 2.0 per cent.

Fed Chair Jerome Powell has said the bank expects to cut rates this year from the current benchmark level of 5.25 to 5.5 per cent, but no change is expected at the Fed’s policy meeting next week. With inflation cooling slowly in the United States, economists and investors now increasingly expect only one or two cuts this year.

– AP