ECB cuts interest rates for the first time in close to 5 years

In a widely anticipated move, the Governing Council of the European Central Bank (ECB) opted to lower the three key ECB rates by 25 basis points, a move that many hope will boost the bloc’s economy, which has stagnated over the last two years as high borrowing rates stifle investment.

The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be decreased to 4.25 per cent, 4.50 per cent and 3.75 per cent respectively, with effect from 12th June 2024.

With regards to the main refinancing operations rate and the marginal lending rate, this is the first cut since March 2016, meanwhile as for the deposit rate, this is the first cut since September 2019.

EU countries faced unrelenting inflation since the end of the pandemic, due to several factors such as supply chain shocks, a surge in consumption and demand post-COVID, and Russia’s war with Ukraine impacting the crucial energy markets. As a result, the ECB steadily increased interest rates in a bid to disincentivise investment and consumption, and stem the tide of inflation.

Since the last ECB Governing Council meeting in September 2023, however, inflation has fallen by more than 2.5 percentage points and the inflation outlook improved markedly.

Underlying inflation has also eased, reinforcing the signs that price pressures have weakened, and inflation expectations have declined at all horizons. Monetary policy has kept financing conditions restrictive. By dampening demand and keeping inflation expectations well anchored, this has made a major contribution to bringing inflation back down.

“At the same time, despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year,” the ECB said in a statement.

The latest Eurosystem staff projections for both headline and core inflation have been revised up for 2024 and 2025 compared with the March projections. Staff now see headline inflation averaging 2.5 per cent in 2024, 2.2 per cent in 2025 and 1.9 per cent in 2026. For inflation excluding energy and food, staff project an average of 2.8 per cent in 2024, 2.2 per cent in 2025 and 2.0 per cent in 2026. Economic growth is expected to pick up to 0.9 per cent in 2024, 1.4 per cent in 2025 and 1.6 per cent in 2026.

In the ECB’s statement, it said that “the Governing Council is determined to ensure that inflation returns to its two per cent medium-term target in a timely manner. It will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim.

“The Governing Council will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction.

“In particular, its interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.

The Governing Council also confirmed that it will reduce the Eurosystem’s holdings of securities under the pandemic emergency purchase programm (PEPP) by €7.5 billion per month on average over the second half of the year. The modalities for reducing the PEPP holdings will be broadly in line with those followed under the asset purchase programm (APP).