ECB cuts interest rates as inflation slows and economic growth falters

The European Central Bank (ECB) cut interest rates again on Thursday as inflation slows and economic growth falters, but provided no substantial clues to its next step, even as investors bet on steady policy easing in the months ahead.

The ECB lowered its deposit rate by 25 basis points to 3.50 per cent in a widely telegraphed move, following up on a similar cut in June as inflation is now within striking distance of its 2 per cent target and the domestic economy is skirting a recession.

With the cut widely expected, investor attention has already shifted to what will come next and how European Central Bank decisions will be shaped by the US Federal Reserve’s widely expected start to its own rate-cutting next week. But the ECB, the central bank for the 20 countries that share the euro, gave nothing away.

“We are not pre-committing to a particular rate path,” ECB President Christine Lagarde told a press conference, using the bank’s standard formula for what it calls its “data-dependent”, meeting-by-meeting approach to policy.

“We are looking at a whole battery of indicators,” she said, noting that September was likely to deliver a low reading of inflation simply because of statistical base effects.

Euro assets were little changed by the move and by the absence of clues on the future rate path, which analysts interpreted as evidence of the ECB’s caution.

“Given that the ECB’s track record of predicting inflation on its way up is rather weak, the European Central Bank will want to be entirely sure before engaging in more aggressive rate cuts,” said Carsten Brzeski, Global Head of Macro at ING.

Lagarde painted a mixed picture of inflation in the euro area continuing to be sustained by rising wages even as overall labour cost pressures moderated and were absorbed by companies.

More dovish ECB policymakers, mainly from the eurozone’s south, have been arguing that recession risks are rising and high ECB rates are now restricting growth far more than needed, raising the risk that inflation could undershoot the target.

But inflation-wary hawks, who are still in a majority, say the labour market remains too hot for the European Central Bank to sit back, and that underlying price pressures, as evidenced in stubborn services costs, raise the risk inflation could surge again.

New economic forecasts did little to settle the debate.

Quarterly projections from the ECB’s staff showed that growth this year will be slightly lower than forecast in June while inflation is still only seen back at target in the second half of next year.

That means few if any policymakers are likely to argue against further easing, with the key divide being how quickly the European Central Bank should move.

Hawkish policymakers have made clear that they see quarterly rate cuts as appropriate, since key growth and wage indicators - which inform the ECB’s own projections - are compiled every three months.

Investors are also divided, with another cut by December fully priced into financial markets but the chance of an interim move in October wavering between 30 per cent and 50 per cent.

With Thursday’s move, the European Central Bank’s deposit rate will fell by 25 basis points to 3.5 per cent.

The refinancing rate, however, was cut by a much bigger 60 basis points to 3.65 per cent in a long-flagged technical adjustment.

The gap between the two interest rates had been set at 50 basis points since September 2019, when the ECB was pumping stimulus into the economy to avert the threat of deflation.

It announced plans in March to narrow the corridor to 15 basis points from Thursday’s meeting, to encourage the eventual rekindling of lending between banks.

Such a revival is still years away, so the ECB’s move is a pre-emptive adjustment of its operating framework.

For now, banks are sitting on 3 trillion euros of excess liquidity which they deposit with the ECB overnight, making the deposit rate in effect its main policy instrument.

Over time this liquidity should dwindle, pushing banks to borrow again from the European Central Bank at the refinancing rate, traditionally the central bank’s benchmark interest rate.

Once that happens, the main rate will regain its headline status, while the narrower rate corridor should help the ECB better manage market rates.

The marginal lending rate, a rarely used instrument, was also cut by 60 basis points to 3.90 per cent.

Eurozone government bond yields were mixed on Thursday after the ECB decided on a widely expected 25 basis points interest rate cut and tweaked its economic forecasts.

The bloc’s borrowing costs dropped on Wednesday, tracking moves in US Treasuries after data showed US underlying inflation remained sticky, curbing expectations for a significant interest rate cut by the Federal Reserve next week.

German 10-year Bund yields were up 1.5 basis points at 2.114 per cent -- roughly unchanged from before the ECB statement -- after falling 5 bps the day before.

Agencies