ECB kicks off rate-cutting cycle
On 6 June 2024, the ECB decided for the first time since September 2019 (when the ECB brought its deposit rate to all-time low of -50 basis points) to cut its three policy rates by 25 basis points each. This decision brought the deposit rate to 3.75% from its cyclical peak of 4%, in place since September 2023.
For the remainder of 2024, KBC expects another rate cut of 25 basis points in September and another one (also of 25 basis points) by the end of 2024, bringing the ECB’s deposit rate to 3.25% at the end of 2024. Although risks of a somewhat slower easing pace remain material.
With its latest rate decision, the ECB takes the lead with respect to the Fed and the Bank of England in what probably is the start of a rate cutting cycle. As mentioned, this was widely expected, not in the least because of the recent, a-typical explicit forward guidance of ECB governors. Against this backdrop, two aspects are worth highlighting. First, at the policy meeting, the ECB refused to explicitly commit to any kind of specific rate-cutting path. The ECB wants to keep options open and underscored (again) being fully data dependent with decisions made on a meeting-by-meeting basis. Nevertheless, during the press conference, ECB president Lagarde said that there was a strong likelihood that the ECB has now entered into a “dialling back phase”, after the previous phases of policy tightening followed by holding rates steady (referring to terminology she used in a previous speech).
Second, at least at first sight, the fact that the first rate cut was decided against the prospect of a a ‘bumpy’ disinflationary path calls for an explanation. For example, the latest headline inflation for the euro area for May 2024 rose to 2.6% (from 2.4%), while underlying core inflation (excluding food and energy prices) rose to 2.9% (from 2.7%). Another example was the mentioned upgrade of the ECB’s staff annual average inflation projection for 2024 and 2025. In response to these concerns, ECB president Lagarde emphasised that, underneath the annual average figures, the ECB staff model keeps consistently pointing to a robust return to the 2% inflation target from the second half of 2025 on. Moreover, she referred to strong wage data in the first quarter of 2024 as one of the drivers of the higher staff inflation trajectory, but added that, in her view, these wage increases reflect substantial one-off catch-up effects, in particular in the German multi-annual wage agreements. Such one-off effects are unlikely to be repeated in the coming years (i.e. are temporary) and are therefore unlikely to de-anchor inflation expectations. Inflation expectations, implied by inflation swaps, seem (so far) to confirm this view. Moreover, agreed wage increases are at least to some extent absorbed by profit margins, thus cushioning their potential inflationary impact.
In sum, today’s rate cut by 25 basis points should be seen as a first step to ease a policy stance that even at 3.75% remains restrictive. At that rate, the deposit rate remains well above any reasonable estimate of what a euro (nominal) neutral rate might be (KBC’s current estimate would be in the range between 2.50% and 2.75%). This restrictive stance is appropriate given the above-target (underlying) inflation and the uncertainties (‘bumps’) that still lie ahead. As progress is made on this disinflationary path, we expect the policy rate to be reduced further, gradually approaching the neutral rate by the end of 2025.