ECB cuts key base rate by 25 basis points, no more information on future rate cuts

foreign exchange trading platform- The European Central Bank cut interest rates by 25 basis points on Thursday (June 6), but did not provide direction on future policy moves. The European Central Bank (ECB) cut all three key base rates for the first time in five years, a move that echoed yesterday's move by the Bank of Canada (BoC). It follows similar decisions by Sweden's Riksbank and Swiss Bank (SNB).

As widely expected, the ECB's rate cut resulted in a 25 basis points (bps) drop in the main refinancing operation rate, the marginal lending facility rate, and the deposit facility rate, which are now 4.25%, 4.50%, and 3.75%, respectively.

The ECB's message is that it will keep its policy rates tight enough as long as it is necessary to meet its inflation target. The rate statement also said that the ECB would not commit to a specific path of interest rates after the rate cut, and would still take a meeting-by-meeting approach, while closely monitoring upcoming data.

The euro rallied slightly after the announcement, though that was largely within expectations and left traders with little leverage given the Fed's already aggressive rate cuts. In terms of market pricing, rates barely changed after the announcement; OIS markets continued to digest expectations for another 25 basis points cut at the September policy-setting meeting.

The rate cut comes on the heels of rising inflation. Inflation in the euro zone rose in May after accelerating in places such as Germany, Spain and France. Eurozone inflation rose to a four-month high, according to estimates by the European Union's statistical office.

The CPI (Consumer Price Index) rose 2.6% year-on-year in May, up from + 2.4% in April and higher than expected + 2.5%. Core inflation was also higher than market expectations, rising to + 2.9% from + 2.7% in the previous period. The increase was mainly due to a rise in service sector inflation, which jumped from + 3.7% in April to + 4.1% in May. Despite the rise in inflation data, many believe that this is not seen as the start of an acceleration in inflation.

ECB staff forecasts

The rise in inflation did, however, prompt ECB staff to raise their inflation expectations, although this is not surprising. Average inflation is expected to be + 2.5% this year, slowing to + 2.2% in 2025 and then to + 1.9% in 2026, according to ECB projections. In terms of economic activity, economic growth is expected to reach 0.9% this year, 1.4% next year and to slow to around 1.6% in 2026.

In other recent data, the unemployment rate fell from 6.5% in March this year to 6.4% in April this year, a record low (and has been since November 2023), which is clearly helping the economic recovery. In terms of economic activity, the seasonally adjusted GDP of the Eurozone Quarter 1 grew by 0.3%, according to the Eurostat estimate (the second estimate).

This follows two consecutive quarterly declines of -0.1% in Q3 and Q4 2023. This is the strongest growth data since Q3 2022. Final revised data for Quarter 1 GDP will be released on June 7. The most recent Eurozone PMI also showed signs of recovery. The HCOB Eurozone Composite PMI Output Index preview value jumped to a 12-month high of 52.3 in May from 51.7 in April.

After raising inflation and growth expectations, the market reduced interest rate cut bets, helping to boost the euro, which traded higher against the dollar without seeing an additional boost from the first US payroll gain.

European Central Bank press conference

Thirty minutes after the rate announcement, Christine Lagarde, president of the European Central Bank, noted that the outlook for inflation had improved markedly. She also reiterated that the ECB would not commit to future rate changes. However, despite the improvement in price pressures, Lagarde commented on service sector inflation and rising wages.

A central bank does not usually raise inflation expectations when it cuts interest rates. However, Ms Lagarde commented on forward-looking indicators of a slowdown in wages this year. She also reiterated that the central bank would keep interest rates tight enough to bring inflation back to its target of + 2.0 per cent.

The most obvious and pressing question was first asked: Why ease policy while raising inflation expectations? The ECB president replied that the move was based on the strengthening of confidence in recent months.

Regarding market pricing, Lagarde really did not want to comment. Her answer was very brief: The market does what the market must do, and we do what we must do.

Another key concern is whether the ECB is entering a "correction" phase. Ms Lagarde responded that the ECB needed data to confirm the path of disinflation and that its pace of action was uncertain. However, she noted that the coming months would be "bumpy".

The latest staff forecasts show that both inflation and economic growth in 2024 have been revised up, which has stimulated the euro following the announcement. The most important medium-term inflation indicator (2026) remains unchanged at 1.9%, but importantly remains below 2%, which may help stabilize inflation expectations. GDP in 2024 has been revised up, from 0.6% to 0.9%, which is good news for the US economy, which has stagnated for the past five quarters.