FRANKFURT — The European Central Bank is set to cut interest rates for the first time in five years on Thursday, offering some welcome relief for the region’s economy — and for its president, Christine Lagarde.
The widely-telegraphed move comes amid massive uncertainty about how many more cuts may follow after that: Investors have slashed their cumulative rate cut expectations for this year by more than half from the peak in December to around 60 basis points today.
Currently, the key ECB deposit rate stands at a record high of 4 percent.
Thursday’s decision will mark the first time in over two decades that it will have lowered borrowing costs in response to a classical easing of inflation pressures, rather than a financial catastrophe hitting the currency union.
As such, Lagarde, who has often been criticized for lacking central banking expertise, has won a major battle. But she has not yet won the war against inflation.
Headline inflation accelerated in May for the first time this year to 2.6 percent, topping analysts’ expectations. Faster-than-expected wage growth and stronger-than-expected economic output have also kept alive the risk that it stays above target for longer than the ECB is wiling to accept.
While analysts generally expect ECB staff to raise their growth and inflation forecasts only marginally – and continue to point to the ECB meeting its 2 percent inflation target – they have warned that underlying pressures, notably in services prices, may cause a further upward revision to the inflation forecast in the September forecast round.
At the same time, stronger-than-expected price pressure in the United States, which is set to keep the Federal Reserve on hold for some time yet, risks constraining the ECB’s easing ambitions, as diverging significantly from the Fed could hurt the euro. Austrian National Bank chief Robert Holzmann is among those who stressed such challenges.
Other hawks, such as executive board member Isabel Schnabel, have warned against rushing into a series of cuts while doves, including the Bank of Italy’s Fabio Panetta, are more concerned about keeping policy unnecessarily tight at a time when Europe has only just escaped a recession. He and ECB chief economist Philip Lane have both stressed that tighter U.S. policy and financial conditions cut both ways.
Financial markets will, as always, seek clues from Lagarde’s press conference as to where she thinks interest rates may land in the coming months — but they may well be disappointed, analysts said.
“The ECB must keep open the idea of further easing, if the data allow it, but also avoid talking itself into another near-certain cut in September,” said Pantheon Macroeconomics’ Claus Vistesen in a note, adding that, in his view, a second cut in July seems off the table.
Barclays analysts, who expect one cut every quarter from Frankfurt for now, anticipate a similar message. “We also expect the Governing Council to reiterate that it will continue to follow a data-dependent and meeting-by-meeting approach, without pre-committing to a particular rate path,” economist Mariano Cena told clients.
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