As widely expected, the European Central Bank (ECB) cut its key policy rates for the first time in five years. The interest rate on the main refinancing operations, the marginal lending facility, and the deposit facility were each lowered by 25 basis points to 4.25%, 4.5%, and 3.75%, respectively.
The ECB’s decision to ease its policy restrictiveness comes after nine months of holding policy rates steady. While the decision had been well-flagged, the incoming economic data over recent weeks has prompted markets to revise their expectations for the policy path, reducing the number and pace of cuts in 2024. ECB President Christine Lagarde today noted that the ECB was not in a “dialing back phase,” signaling that back-to-back rate cuts are unlikely, and therefore adding conviction to reduced rate cut expectations.
Economic backdrop
The justification for starting policy rate cuts is evident. The Euro area’s inflation backdrop has improved immensely over the past year, with inflation in late 2023 falling at a faster pace than it had risen and inflation expectations remaining firmly anchored.
However, the rationale for further rate cuts beyond June has become increasingly unclear recently. Euro area disinflation progress has started to stall with the latest inflation print surprising to the upside, while the ECB’s indicator of negotiated wages rose in Q1, defying the central bank’s expectations for an easing. In addition, evidence of solid employment growth and a cyclical economic upturn have reduced the market’s confidence that inflation will trend lower over the coming months.
