The ECB on Thursday became the second G7 central bank in two days to cut rates.
Billed as a landmark decision, the move was a foregone conclusion. The bank spent months laying the groundwork and refining the message.
“Based on an updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission, it is now appropriate to moderate the degree of monetary policy restriction after nine months of holding rates steady,” the new statement read. “The inflation outlook has improved markedly and inflation expectations have declined at all horizons.”
Somewhat amusingly, the cut comes just days after Eurostat reported the first month-to-month increase in the annual rate of core inflation since last June. Underlying price growth ran 2.9% last month which, if I’m thinking about this correctly, is a faster pace than 2%, the bank’s target. (Don’t worry: It’s transitory.)
Derision aside, the ECB’s rate-hiking campaign went remarkably well, all things considered. Europe was staring down an existential energy crisis which drove overall price growth into the double-digits at one juncture, prompting a patchwork fiscal response from national governments, whose rescue efforts varied both in scope and character.
It was far from clear that rate hikes were the solution to an inflation problem attributable in large part to a war-driven surge in energy and food prices. There was also some concern that Europeans struggling with the worst cost of living crisis in a generation needed an aggressively hawkish central bank about like Ukrainians needed a(nother) bullet in the head.
We’ll never know whether the ECB was actually to thank for the restoration of something that at least resembles price stability in Europe. I personally doubt it, but barring some new turn for the worse, Christine Lagarde’s crisis management efforts will go down as a success.
The bank gave itself a hearty pat on the back Thursday. “Monetary policy has kept financing conditions restrictive,” the statement said. “By dampening demand and keeping inflation expectations well anchored, this has made a major contribution to bringing inflation back down.”
To reiterate (because this really can’t be emphasized enough): This could’ve gone far (far) worse, and on any number of vectors. If you would’ve told Lagarde two years ago that by summer of 2024, after 450bps of rate hikes, headline inflation in Europe would be ~2.5% and the euro-zone economy would be coming off its best quarter in six after suffering only a mild recession, she would’ve said, “I’ll take it.”
To be sure, services sector inflation in Europe remains very high and policymakers are compelled to guard against any rekindled wage-price dynamic. The bank didn’t mince words in that regard. “[D]espite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated,” the statement cautioned. “Inflation is likely to stay above target well into next year.”
From a 30,000-foot view, the region’s economy lacks dynamism and looks moribund compared to the US juggernaut. Indeed, you could argue that between divisive politics, the lack of a unified fiscal framework, defense concerns and energy dependence, the outlook’s pretty bleak over the longer run. As Bloomberg put it, Europe’s “languishing with anemic growth, weak productivity, poor demographics and bloated public finances in key countries.” The linked article described those problems as “decades in the making.” In truth, Europe hasn’t been a paragon of pizzazz since the High Renaissance.
The ECB on Thursday set out new projections for growth and inflation. The economy will expand 0.9% in 2024, 1.4% in 2025 and 1.6% in 2026, staff reckons.
The inflation outlook was revised higher, which made for a somewhat slapstick juxtaposition with the rate cut. I’m sure the comedic irony won’t be lost on legions of critics who make their living telling bad macro jokes.
ECB staff now sees headline inflation averaging 2.5% this year, 2.2% next and 1.9% in 2026. As for core inflation, it’ll run 2.8% in 2024, 2.2% in 2025 and 2.0% in 2026.
2024 marks the first time the ECB embarked on a cutting cycle before the Fed and, as Bloomberg noted in the linked article above, it’s the “first time in two decades policymakers get to start a monetary-easing cycle without having their hand forced by a financial emergency.”
The forward guidance was vague. The bank’s “determined to ensure that inflation returns to its 2% medium-term target in a timely manner [and] will keep policy rates sufficiently restrictive for as long as necessary to achieve this aim.” Policy decisions from here will “follow a data-dependent and meeting-by-meeting approach.”
Analysts generally described Thursday’s move as a “hawkish cut.” Citing unnamed officials, Bloomberg later reported that the bank has “all but ruled out” a follow-up cut in July and may not be inclined to cut again in September either.
