ECB Cuts Key Benchmark Rates

In a move that echoes the Bank of Canada (BoC) yesterday, the European Central Bank (ECB) has cut all three key benchmark rates today, marking its first rate cut in five years. This also followed similar decisions by Sweden’s Riksbank and the Swiss National Bank (SNB).

As widely anticipated, the ECB’s rate reduction has resulted in a 25 basis points (bps) decrease in the main refinancing operations rate, the marginal lending facility rate, and the deposit facility rate, now standing at 4.25%, 4.50%, and 3.75%, respectively.

Ultimately, the ECB maintained the message that they would keep policy rates sufficiently restrictive for as long as necessary to reach the inflation target. The rate statement also communicated that the ECB would not commit to a particular rate path following the cut and would still adopt a meeting-by-meeting approach while closely monitoring incoming data.

There was a marginal upside move in the euro (EUR) following the announcement, though this was largely expected as there was little edge for traders to exploit given the cut was baked in: a hawkish cut. Regarding market pricing, little change was seen after the rate announcement; the OIS market continued to price in another 25bp cut at September’s policy-setting meeting.

The rate cut comes on the heels of an increase in inflation. The May inflation reported a rise for the euro area, following an acceleration in regional prints (Germany, Spain and France). According to the Flash estimate from Eurostat, euro area inflation increased to a four-month high.

Year-on-year CPI (Consumer Price Index) for May inflation rose by +2.6% from +2.4% in April, bettering the +2.5% median estimate. Core inflation also rose above consensus at +2.9% from the prior +2.7% over the same period. The increase was largely due to a rise in services inflation, jumping +4.1% in the twelve months to May from +3.7% in April. Irrespective of the increase in inflation data, many desks believe this is not considered the start of an acceleration in inflation.

ECB Staff Projections

The rise in inflation, however, did see ECB staff raise inflation forecasts, though there was not really anything surprising here. According to the ECB forecasts, inflation is expected to average +2.5% this year, slow to +2.2% in 2025, and subsequently to +1.9% in 2026. In terms of economic activity, growth is expected to increase to +0.9% this year, +1.4% the following year, and moderate around +1.6% in 2026.

In other recent data, unemployment fell to a fresh record low of 6.4% in April this year from 6.5% in March (which remained the case since November 2023) and is clearly aiding the recovery. In terms of economic activity, according to the Flash estimate (second estimate) from Eurostat, Q1 seasonally adjusted GDP increased by +0.3% in the euro area.

This follows two consecutive quarterly declines of -0.1% in Q3 and Q4 2023. This marks the strongest growth reading since Q3 of 2022. The final Revised reading of Q1 GDP is due on 7 June. The recent euro area PMIs also demonstrated signs of a recovery. The HCOB flash eurozone composite PMI output index jumped to 52.3 in May from 51.7 in April, marking a 12-month peak.

ECB Press Conference

Thirty minutes after the rate announcement, ECB President Christine Lagarde took the stage and noted that the inflation outlook has improved markedly. She also reaffirmed that the central bank is not committing to future rate moves. However, while there has been improvement in price pressures, Lagarde commented on the elevated services inflation and wages.

A central bank cutting rates and, at the same time, increasing inflation forecasts are not usually seen on the same page. However, Lagarde commented on forward-looking indicators signalling wage moderation over the year. She also reaffirmed that the central bank would keep rates sufficiently restrictive to bring inflation back down to the +2.0% target.

The most obvious presser question was asked first: why ease policy while increasing inflation forecasts? The ECB head replied that the move is based on increased confidence in recent months. Regarding market pricing, Lagarde really did not want to comment and cut things incredibly short with the following response: ‘Markets do what markets have to do, and we do what we have to do.’ This may serve as a good screensaver.

Another key question asked was whether the ECB is entering a dialling back phase. Lagarde responded that the central bank needs data to confirm the disinflationary path and the speed at which the ECB travels is uncertain. However, she noted that the next few months will be ‘bumpy’.

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