The European Central Bank's 25 basis point rate cut, ahead of the Federal Reserve, underscores the differing post-COVID economic recoveries between the Euro area and the U.S. With Euro area growth lagging and inflation down from its peak, the ECB's proactive stance is warranted. However, this divergence could pressure the euro and reignite inflationary concern—expect future ECB cuts to likely align with the Fed's timeline.

ECB vs. Fed policy rate path
1991–present

European Central Bank and Federal Reserve policy rate path since 1991
Source: Bloomberg, Principal Asset Management. Forecasts are Principal Asset Management forecasts. Data as of June 7, 2024.

On Thursday, the European Central Bank (ECB) delivered a 25 basis point policy rate cut. By contrast, the Federal Reserve (Fed) is set to keep rates on hold at its meeting this month.

Typically, central banks wait for the Fed to reduce rates before they move. In fact, until yesterday, the ECB had never cut rates ahead of the Fed. But with the Euro area experiencing a meaningfully weaker growth outcome post-COVID than the U.S., and Euro area headline inflation having plunged from a peak of 10.6% to 2.6%, the ECB had strong reason to not wait for the Fed.

Nonetheless, the ECB will be wary of its diverging policy path. A widening gap between U.S. and Euro area policy rates risks putting downward pressure on the euro, in turn adding to inflationary pressures—a dynamic the ECB must fear. Although the Euro area’s inflation fight has been impressive, recent inflation and wage data have surprised to the upside. Further euro depreciation would add to creeping concerns that Euro area disinflation may be stalling.

Some global policy coordination is required. The next ECB rate reductions are likely in September and December—the same months the Fed is likely to cut. However, if the Fed delays the start of its own easing cycle until early-2025, the ECB’s next move may be equally delayed. Higher for longer in the U.S. implies higher for longer in Europe.

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