Home Estate Planning ECB to cut interest rates but path beyond June ‘still open’

ECB to cut interest rates but path beyond June ‘still open’

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The European Central Bank (ECB) is almost certain to start cutting interest rates tomorrow, but investors are much less clear about the path in the remainder of the year.

Investors have fully priced in a 25 basis point cut tomorrow, which would bring down the benchmark borrowing rate from its record high of four per cent but would still leave interest rates at a relatively high level.

“The rationale behind the cut will be to very gradually reduce the level of monetary policy restrictiveness without ending restrictiveness,” Carsten Brzeski, ING’s global head of macro said.

However, rate-setters are likely to be deliberately vague about the appropriate response over the remainder of the year as they await further signs that price pressures are easing.

Figures out last week showed that prices across the eurozone rose slightly faster than expected, coming in at 2.6 per cent. The services component, which more accurately captures home-grown price pressures, jumped back over four per cent.

Wage growth meanwhile climbed back up to record levels in the first quarter of 2024, with negotiated pay settlements rising 4.7 per cent from a year ago. Most economists had expected pay growth to ease.

This means that although a cut tomorrow is a near certainty, markets have scaled back their expectations for cuts later in the year. Most economists now think that the ECB will only cut rates twice, although a third is a possibility.

“It’s the outlook beyond June that is still open,” analysts at ING said. “We expect the ECB to scale back its guidance endeavour and swing back towards data dependency after stronger-than-expected wages and inflation figures.”

Alongside its latest rate decision, the ECB will publish its quarterly economic forecasts, which are likely to show more persistent inflation. Gabriele Foà, portfolio manager at Algebris Investments, said this would create “an awkward backdrop for the cut”.

“As things stand, we believe an ECB cut this week may soon be viewed as a policy mistake,” he said.

Another factor constraining the potential pace of rate cuts is how much the ECB will diverge from the US Federal Reserve. Markets do not think the Fed will cut rates until at least September, reflecting the underlying strength of the US economy.

However, if the ECB were to take a markedly different approach to the Fed, then the euro would likely weaken significantly against the dollar, making imports more expensive.

The Bank of England meanwhile is likely to cut rates in either August or September.

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