The ECB will reduce borrowing costs

A big day for the European Central Bank: for the first time since September 2019, the ECB will cut borrowing costs this Thursday. However, beyond the pre-announced 25 basis point rate cut, the ECB is likely to provide little clarity on its monetary policy outlook going forward. That the ECB will make another (reduction) move on July 18 already seems unlikely. However, we don’t expect the bank to rule it out completely. The answer to the question of how quickly the ECB will ease policy after it cuts its deposit rate from 4.0% to 3.75% on June 6 will probably boil down to “it all depends on the data.”

We maintain our long-term view that the ECB will wait before making a second 25 basis point cut until it can consider new quarterly growth and inflation forecasts on September 12. As before, we still expect the ECB to raise the deposit rate from the current 4% to 3.25% by the end of 2024 in quarterly moves of 25 basis points (June, September and December 2024).

If lower household energy costs push inflation to 2% in late 2024 and early 2025, as we forecast, the ECB may raise deposit rates to 2.5% next summer. In 2026, however, inflation will likely recover to 2.5%. A deepening labor shortage will likely prevent wage inflation from falling well below 4% for a sustained period. As a result, the ECB may need to raise the deposit rate to 3% in 2026, the level we consider neutral. Overall, the eurozone economy is on track for a gradual, steady recovery.

While remarkable that the ECB is well ahead of the US Federal Reserve, the transatlantic difference in inflation and growth more than justifies it, in our view. If anything, the five quarters of stagnation in the eurozone economy from autumn 2022 to the end of 2023 suggest that the ECB may have overreacted with rate hikes in response to the temporary rise in imported inflation in the wake of the invasion of Russia in Ukraine. From this perspective, somewhat lower interest rates make sense.