The European Central Bank signals interest rate cuts and there is limited room for interest rate cuts.
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Recently, the latest statements and economic data from the European Central Bank have revealed signals that monetary policy may be loosened. Analysts pointed out that the European Central Bank may still start to cut interest rates in June, but it is expected that the space for future interest rate reductions will be limited.
Send interest rate cut signal
The European Central Bank issued an announcement on April 11 that the main refinancing interest rate, marginal lending rate and deposit mechanism interest rate will remain unchanged at 4.50%, 4.75% and 4.00% respectively. This is the fifth consecutive time the European Central Bank has kept interest rates unchanged since October last year.
The announcement said that the European Central Bank will not commit to the direction of its interest rates and will continue to determine interest rate levels based on data and through successive monetary policy meetings. “If factors such as inflation dynamics, prospects, and the strength of monetary policy transmission enhance confidence in achieving the medium-term inflation target, it will be appropriate to lower the current interest rate level.”
ECB President Christine Lagarde said conditions will be in place for a rate cut at the next meeting in June, unless inflation unexpectedly picks up in the spring.
Experts generally believe that the above remarks imply that the European Central Bank may announce an interest rate cut at its next monetary policy meeting scheduled to be held in June.
Jörg Cramer, chief economist at Commerzbank, said that the European Central Bank unexpectedly strengthened its interest rate cut signal and that unless there are major changes, the European Central Bank will lower interest rates in June.
Carsten Brzeski, head of ING’s macro research department, said this is the first time the European Central Bank has mentioned loosening monetary policy in an official announcement recently, opening the door to an interest rate cut in June.
Eurozone inflation has recently fallen from a high of 10.6% in October 2023 and is close to the 2% target. The euro zone inflation rate was 2.4% in March, and the core inflation rate excluding energy, food, tobacco and alcohol prices fell to 2.9%.
The European Central Bank expects euro zone inflation to fluctuate around current levels this year and fall to 2% by mid-2025.
Unfavorable factors limit inflation slowdown
A number of recent U.S. economic data show that inflation is unexpectedly stubborn. Inflation in the United States accelerated in March, with CPI increasing by 3.5% year-on-year, higher than expected. There are expectations that the Federal Reserve may delay cutting interest rates.
When asked whether this would have an impact on the ECB’s rate cut schedule, Lagarde reiterated that the ECB’s decision “depends on the data, not the Fed” and that the Fed is only one of the global factors that need to be considered. Lagarde pointed out that the nature of inflation and economic conditions in the two regions are not the same.
Analysts believe that the economic growth rate of the United States in the fourth quarter of 2023 was 3.3% on an annual basis, and its inflation was mainly driven by demand growth driven by the government’s large-scale stimulus measures. Inflation in Europe is mainly caused by supply chain problems. High interest rates have driven down prices, ultimately suppressing demand from businesses and households. Currently, European economic activity continues to be weak, and weak economic growth momentum has led to downward inflation.
Two surveys released by the European Central Bank on April 12 showed that the euro zone’s economy will barely achieve growth this year; at the same time, large companies in the euro zone face shrinking investment, layoffs and poor retail sales.
Fiscal policy is another key factor causing the divergence of inflation in Europe and the United States. Reuters reports that the U.S. government’s budget deficit this year may reach 5.6% of gross domestic product (GDP) and will increase further in 2025. However, the euro zone’s fiscal deficit is shrinking, with the budget deficit expected to fall to 2.9% this year and fall again in 2025.
However, economists warn that over time, the inflation problems facing the United States are likely to be transmitted to Europe, although the extent may be more moderate. The euro area still faces many of the same headwinds as other regions, which may limit the extent to which inflation slows.
Brzeski predicts that the development of U.S. inflation may lead the general direction of inflation in the euro zone, with a lag period of about half a year.
Analysts believe that the performance of the labor market is also crucial. Eurozone unemployment is at historically low levels, but underemployment levels are higher than in the United States. Moreover, the high employment rate in the euro zone is largely due to companies hoarding labor for fear of losing skilled workers, but the United States is creating new jobs at a much faster rate than expected. Falling labor productivity could also exacerbate inflation in Europe, as it means higher unit labor costs, which will ultimately be passed on to prices.
At the same time, Europe will still be affected by rising commodity prices like other countries.
Since the beginning of this year, crude oil prices have rebounded significantly, becoming one of the biggest drag factors on the fall in inflation this year. A rebound in crude oil prices is likely to push up prices in the second half of this year.
The European Central Bank pointed out that the service industry inflation rate is still as high as 4.0%, which is a sign of greater price pressure. Lagarde also said the energy price shock had a “significant impact”. The European Central Bank is paying close attention to developments such as the recent rise in oil prices.
Room for Eurozone interest rate cuts may be limited
Analysts believe that due to the significant differences in the current inflation situation in Europe and the United States, the European Central Bank may still cut interest rates before the Federal Reserve. However, due to the same adverse factors, inflation concerns still exist, and the euro zone has limited space to cut interest rates.
Brzeski said that U.S. inflation levels are rising again, indicating that the risk of rising inflation still exists. Taking into account the recent surge in international oil prices and other factors, the European Central Bank has limited room to cut interest rates.
Deutsche Bank said that taking into account factors such as slowing growth, lower inflation, and tightening fiscal policy, the European Central Bank still has reasons to act independently of the Federal Reserve and cut interest rates in June. However, over time, the ECB’s actions will be limited because the euro zone and the United States are each other’s important trading partners and the impact on the euro exchange rate needs to be considered.
Some experts worry that if it cuts interest rates before the Federal Reserve, the European Central Bank will face inflationary pressures caused by the depreciation of the euro, because the depreciation of the euro may push up the price of European imported goods, especially energy.
Market expectations that the European Central Bank may cut interest rates soon and that the Federal Reserve may delay a rate cut have weakened the euro. On April 12, the U.S. dollar index, which measures the U.S. dollar against six major currencies, rose 0.72% and closed at 106.038 in the late foreign exchange market. It once reached a five-month high of 106.09 during the session. As of late trading in New York, 1 euro was worth $1.0639, down from $1.0726 on the previous trading day. It once fell to 1.0621 dollars per euro, the lowest level since November 3 last year.
Recently, U.S. labor market and inflation data have led to market expectations for an interest rate cut by the Federal Reserve falling again. Expectations for the Fed to cut interest rates by at least 25 basis points in June have fallen to about 25% from more than 50% a week ago, while expectations for a July rate cut have fallen to about 50% from more than 70%, according to the CME FedWatch tool. %.
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