European Central Bank cuts rates as bets build on a summer pause

Khaleej Times

2 days ago

The European Central Bank cut interest rates as expected on Thursday and said it believed it was now well-positioned to cope with global economic uncertainty, as market bets grew on a summer pause in its year-long easing cycle.
The ECB has now lowered borrowing costs eight times, or by 2 percentage points since last June, seeking to prop up a euro zone economy that was struggling even before erratic U.S. economic and trade policies dealt it further blows.
With inflation in line with its 2% target and the cut well flagged, the focus has shifted to the ECB's message about the path ahead, especially since at 2%, rates are now in the "neutral" range where they neither stimulate nor slow growth.
"At the current level we believe we are in a good position to navigate the uncertain circumstances that will be coming up," ECB President Christine Lagarde told a press conference, while repeating that it would not "pre-commit" to a rate path.
Lagarde said policymakers were "virtually unanimous" in agreeing the rate cut, pursuing the bank's most aggressive easing cycle since the 2008/2009 global financial crisis.
The euro was little changed around $1.1426, while government bond yields dipped. Money markets slightly reduced their bets on any further rate cuts by year-end to just 25 basis points - one single move.
Falling energy prices and a stronger euro could put further downward pressure on inflation, said Lagarde, adding that effect could be reinforced if higher tariffs led to lower demand for euro exports and re-routing of overcapacity to Europe.
On the other hand, a fragmentation of global supply chains could raise inflation by pushing up import prices and adding to capacity constraints in the domestic economy, she said.
Investors are already pricing in a pause in cuts in July, and some conservative policymakers have advocated a break to give the ECB a chance to reassess how exceptional uncertainty and policy upheaval at home and abroad will shift the outlook.
While ECB board member and chief hawk Isabel Schnabel has made explicit calls for a pause, others have been more cautious and Lagarde is likely to stick to language that leaves the ECB's options open, as the outlook is prone to sudden changes.
The case for a pause rests on the premise that the short- and medium-term prospects for the currency bloc differ greatly and may require different policy responses.
Inflation could dip in the short term - possibly even below the ECB's target - but increased government spending and higher trade barriers may add to price pressures later.
The added complication is that monetary policy impacts the economy with a 12-to-18 month lag, so support approved now could be giving help to a bloc that no longer needs it.
Investors still see at least one more rate cut later this year, however, and a small chance of another move later on, especially if U.S. President Donald Trump's trade war intensifies.
DIVERGENT OUTLOOK
Acknowledging near-term weakness, the ECB cut its inflation projection for next year.
Trump's tariffs are already damaging activity and will have a lasting impact even if an amicable resolution is found, given the hit to confidence and investment.
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%, even if projections show it back at target in 2027.
Further ahead, the outlook changes significantly.
The European Union is likely to retaliate against any permanent U.S. tariffs, raising the cost of trade. Firms could 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 due to an ageing population will keep wage pressures elevated.