ECB cuts interest rates as growth slows

Frankfurt. The European Central Bank cut interest rates again on Thursday in the face of slowing inflation and economic growth, but gave little clue as to what its next move would be, at a time when investors are betting on continued easing of monetary policy in the coming months.

The ECB cut its deposit rate by 25 basis points to 3.50 percent in a widely telegraphed move, following a similar cut in June, as inflation is now within a whisker of its 2 percent target and the local economy teeters on the brink of recession.

With widespread anticipation, investors’ attention has already turned to what comes next, but the ECB shed no light on the matter, sticking to its guidance that decisions will be taken on a meeting-by-meeting basis, with no pre-commitment to any particular rate path.

“The Governing Council will continue to follow a data-driven approach on a meeting-by-meeting basis to determine the appropriate level and duration of tightening,” the ECB said in a statement. “The Governing Council is not pre-committing to a specific rate path.”

Investors’ attention now turns to ECB President Christine Lagarde’s press conference at 12:45 GMT, where she will be questioned about the outlook for interest rates and how the expected rate cut by the US Federal Reserve may affect the ECB.

Economists believe the most he will do is keep the door open to another cut in October by saying all meetings, including the next one, are “live.”

“Domestic inflation remains high as wages continue to rise at a high pace,” the ECB said. “However, labour cost pressures are moderating and profits are partially cushioning the impact of rising wages on inflation.”

The most easing ECB policymakers, mainly from the southern eurozone, have argued that recession risks are rising and that the ECB’s high rates are restricting growth much more than necessary, raising the risk that inflation will miss its target.

But inflation-wary hardliners, who remain in the majority, say the labour market remains too tight for the ECB to sit back and that underlying price pressures, evidenced by persistently high service costs, raise the risk of inflation rising again.

New forecasts

The new economic forecasts did little to settle the debate.

The ECB’s quarterly projections indicate that growth this year will be slightly lower than expected in June, while inflation will not return to target until the second half of next year.

This means that few, if any, policymakers will oppose further easing and that the main disagreement is over how quickly the ECB should act.

Hardline policymakers have made clear they consider quarterly rate cuts appropriate, as key indicators of growth and wages — which inform the ECB’s own projections — are compiled every three months.

Investors are also divided: a further rate cut in December is already priced in on the financial markets, while the probability of a rate cut in October is between 30 and 50 percent.

Technical rate cut

With Thursday’s decision, the ECB’s deposit rate was lowered by 25 basis points to 3.5 percent. The refinancing rate, however, was cut by 60 basis points to 3.65 percent, a long-announced 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 stave off the threat of deflation.

In March, it announced plans to reduce the gap to 15 basis points starting at Thursday’s meeting, to encourage the eventual revival of lending between banks.

There are still years to go before such a recovery takes place, so the ECB’s measure is a preventive adjustment of its operational framework.

At the moment, banks have €3 trillion of excess liquidity on deposit with the ECB for one day, making the deposit rate their main monetary policy instrument.

Over time, this liquidity is expected to diminish, prompting banks to borrow again from the ECB at the refinancing rate, traditionally the central bank’s benchmark interest rate.

Once this happens, the main rate will regain its reference status, while the narrowing of the rate gap should help the ECB to better manage market rates.

The marginal lending rate, a rarely used instrument, was also reduced by 60 basis points to 3.90 percent.

GDP weakness

Weak growth is one of the main reasons inflation has eased, with gross domestic product (GDP) in the 20 countries that share the euro expected to grow by 0.8 percent this year, down from the 0.9 percent forecast three months ago.