European Central Bank Cuts Interest Rates By 0.25%, But Projects Inflation 'Above Target Well Into Next Year'

The European Central Bank lowered interest rates by 25 basis points on Thursday, a move that was largely anticipated by the market, indicating the need to “moderate the degree of monetary policy restriction after nine months of holding rates steady.”

The new interest rates are set at 4.25% for main refinancing operations, 4.5% for the marginal lending facility and 3.75% for the deposit facility.

This is the first ECB rate cut since March 2016 for both the main refinancing operations rate and the marginal lending rate, and the first reduction in the deposit rate since September 2019.

Furthermore, the ECB is the second major central bank to enact a rate cut this week, following the Bank of Canada’s similar 25-basis-point reduction in the policy rate on Wednesday.

ECB Revises 2024 Growth Outlook, Inflation To The Upside

The ECB statement indicates that headline inflation has fallen by 2.5 percentage points since September 2023 and “the outlook has improved markedly.”

Frankfurt also warned that “domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year.”

Frankfurt also issued the June staff economic projections, which compared to March signal an upward revision for both growth and inflation for 2024. The central bank also made upward adjustments to expectations for price pressures next year.

Headline inflation is now projected to average 2.5% in 2024 (up by 0.2 percentage points from March), 2.2% in 2025 (up by 0.2 percentage points from March) and 1.9% in 2026 (unchanged).

Core inflation projections have also been revised upward by 0.2 percentage points to 2.8% for this year. Projections for 2025 have been raised by 0.1 percentage points to 2.1%, while those for 2026 were kept unchanged at 2.0%.

Output growth is now expected to average 0.9% in 2024 (up from 0.6% in March), 1.4% in 2025 (down from 1.5% in March) and 1.6% in 2026 (unchanged).

The ECB continues to reiterate that future policy decisions will depend on the evolution of data, following a meeting-by-meeting approach.

Market Reactions

The euro, as tracked by the Invesco CurrencyShares Euro Currency Trust FXE, rose by 0.1% to 1.0885 against the dollar minutes after the ECB statement, as investors took as “hawkish” the upward revisions on inflation.

Yields on major European sovereign bonds rose by about 4 basis points, with the 10-year Bund rising to 2.55%.

European equity indices trimmed session gains in reaction to the ECB decision, after hitting all-time highs earlier this morning.

Photo via Shutterstock.