ECB to cut rates again as the case builds for a summer pause

Reuters

2 days ago

FRANKFURT, June 5 (Reuters) - The European Central Bank is almost certain to cut interest rates again on Thursday and keep all options on the table for subsequent meetings, even as the case grows for a pause in its year-long easing cycle.
The ECB has cut rates seven times in 13 months as inflation eased from post-pandemic highs, seeking to prop up a euro zone economy that was struggling even before erratic U.S. economic and trade policy dealt it yet another blow.
With inflation now safely in line with its 2% target and a cut flagged by a host of policymakers, Thursday's decision will be uncontroversial, with the focus on what signals ECB President Christine Lagarde might send about policy ahead.
Investors are already pricing in a pause in July, and some conservative policymakers have advocated a break to give the ECB a chance to reassess how exceptional uncertainty and policy upheaval both at home and abroad will shift the outlook.
"Getting the hawks to support a June cut may require a hint of conditional patience: an implicit willingness to pause in July and wait until September before easing again, as long as there were no major downside surprises in the meantime," Deutsche Bank analysts said in a note.
The case for a pause rests on the premise that the short- and medium-term outlooks for the 20-country currency bloc differ greatly and may require a different policy response.
Inflation could dip in the short term, possibly even below the ECB's target, but increased spending and higher trade barriers could add to price pressures later.
The added complication is monetary policy impacts the economy with a 12-to-18 month lag, so that support approved now could be giving help to a bloc that no longer needs it.
A cut on Thursday would take the deposit rate to 2.0%, which the ECB considers "neutral" - no longer holding back the economy but not yet stimulating it either.
Acknowledging near-term weakness, the ECB is expected to cut both its growth and inflation projections for next year.
U.S. President Donald Trump's trade war is already damaging activity and will have a lasting impact even if an amicable resolution is found, given the hit to confidence and investment.
This sluggish growth, along with lower energy costs and a strong euro, will curb price pressures.
"Uncertainty around tariffs is extremely elevated, and that is not conducive to firms taking longer-term decisions around investment and hiring," Investec economist Sandra Horsfield said. "In the near term (that) will be a disinflationary force in its own right, quite irrespective of where tariffs eventually settle."
Most economists think inflation could fall below the ECB's 2% target next year, triggering memories of the pre-pandemic decade when price growth persistently undershot 2%.
Further ahead, the outlook changes significantly.
The European Union is likely to retaliate against any permanent U.S. tariff, raising the cost of international trade. Firms may meanwhile relocate some activity to avoid trade barriers but changes to corporate value chains are also likely to raise costs.
Higher European defence spending, particularly by Germany, and the cost of the green transition could add to inflation while a shrinking workforce as the bloc's population ages will keep wage pressures elevated.
"We think the window for ECB rate cuts will close over the late summer," UBS economist Reinhard Cluse said.
"We believe the ECB might have to hike rates again in late 2026 to counter rising inflation pressure in 2027, amid a euro zone - German - labour market that is subject to structural tightness during the demographic transition."