For the second time in the current cycle of monetary policy easing, the European Central Bank cut interest rates, confirming market expectations.
In particular, as stated in the relevant announcement, the Board of Directors decided today to reduce the interest rate on the deposit acceptance facility – the interest rate through which it gives the direction of monetary policy – by 25 basis points.
In line with the Governing Council’s updated assessment of the outlook for inflation, the dynamics of core inflation and the strength of monetary policy transmission, it is now appropriate to take a further step towards easing the degree of contractionary monetary policy .
Thursday’s decision to cut the ECB’s benchmark deposit rate for the second time this year comes as the US Federal Reserve is expected to start cutting borrowing costs next week.
Major central banks have begun cutting interest rates in response to signs that inflationary pressures have eased. Some analysts believe the ECB is likely to cut interest rates again in both of its remaining meetings this year.
Eurozone inflation slowed in August to a three-year low of 2.2%, from 2.6% in July. Falling industrial output in Germany and Italy has also raised concerns that the Eurozone economy is slowing after a brief period of growth at the start of the year.
The ECB’s estimates of inflation and interest rates
Recent inflation data has been broadly in line with expectations, and the latest ECB staff projections confirm earlier inflation outlooks. According to experts, headline inflation will average 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026, as in the June projections.
Inflation is expected to pick up again towards the end of this year, in part because previous sharp declines in energy prices will no longer be factored into annual rates. Inflation is then expected to decrease to a level converging towards our target in the second half of next year. In terms of core inflation, the projections for 2024 and 2025 have been revised slightly upwards as services price inflation is higher than expected. At the same time, experts continue to expect a rapid decline in core inflation, from 2.9% this year to 2.3% in 2025 and 2.0% in 2026.
Domestic inflation remains high as wages continue to rise at an increased rate. However, labor cost pressures are easing and earnings are partially offsetting the impact of higher wages on inflation. Financing conditions remain tight and economic activity remains subdued, reflecting subdued private consumption and private investment. Experts now forecast the economy to grow at a rate of 0.8% in 2024, which will accelerate to 1.3% in 2025 and 1.5% in 2026. This is a slight downward revision compared to the projections of June, which is mainly due to the smaller contribution of domestic demand in the following quarters.
The Governing Council is determined to ensure that inflation returns to its medium-term target of 2% in time. It will keep policy rates sufficiently restrictive for as long as necessary to achieve this goal. The Governing Council will continue to take an evidence-based approach and make decisions on a meeting-by-meeting basis to determine the appropriate extent and duration of the contractionary change in monetary policy. In particular, its interest rate decisions will be based on its assessment of the outlook for inflation in light of incoming economic and financial data, the dynamics of underlying inflation and the tightness with which monetary policy is transmitted. The Board of Directors does not commit in advance to a specific course of interest rates.
As announced on 13 March 2024, certain changes to the operational framework for the implementation of monetary policy will take effect from 18 September. More specifically, the spread between the main refinancing operations rate and the deposit facility rate will be set at 15 basis points. The spread between the marginal funding rate and the main refinancing rate will remain unchanged at 25 basis points.
Key ECB interest rates
The Board decided to reduce interest rates on the deposit facility by 25 basis points. Deposit facility rates are the rate at which the Governing Council gives the direction of monetary policy. In addition, as announced on 13 March 2024 following the review of the operational framework, the spread between the main refinancing operations rate and the deposit facility rate will be set at 15 basis points. The spread between the marginal funding rate and the main refinancing rate will remain unchanged at 25 basis points. As a result, the interest rate on the deposit acceptance facility will be reduced to 3.50%. The interest rate on the main refinancing operations and the interest rate on the marginal financing facility will be reduced to 3.65% and 3.90% respectively. The changes will take effect from September 18, 2024.
APP and PEPP
The APP portfolio is being reduced at a measured and predictable pace, as the Eurosystem no longer reinvests principal amounts from redeeming securities at maturity.
The Eurosystem no longer reinvests all principal amounts from the redemption of securities purchased under the PEPP as they mature, reducing the size of the PEPP portfolio by €7.5 billion per month on average. The Board intends to end reinvestments under the PEPP scheme at the end of 2024.
The Governing Council will continue to apply flexibility to the reinvestment of amounts from the redemption of PEPP portfolio securities as they mature in order to address risks to the monetary policy transmission mechanism related to the pandemic.
Refinancing operations
As banks repay the amounts borrowed under targeted longer-term refinancing operations, the Governing Council will regularly assess how targeted financing operations and their continued repayment contribute to the direction of its monetary policy.
Source OT
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