The European Central Bank plans to cut interest rates before the U.S. Federal Reserve on Thursday. This will make the eurozone its biggest economy in the rich world to start lowering the cost of borrowing money for businesses and consumers as the inflation that grew after Russia’s full-scale invasion of Ukraine slowly goes down.
According to ECB President Christine Lagarde and other officials, the rate will almost certainly be cut by a quarter percent from its current record high of 4% when the bank’s 26-member governing council meets at its building offices in Frankfurt, Germany.
For the 20 European Union countries that use the euro and for which the ECB sets monetary policy, Lagarde said at the end of last month that she was “really confident” that inflation was under control. Analysts are sure that a rate cut will happen on Thursday based on what she said and what other ECB officials have said.
This would be different from how things were before the inflation spike. At that time, the Federal Reserve took the lead in tightening credit by raising interest rates starting in March 2022. This made mortgage rates go up but also helped people with money in CDs or money market funds earn more.
Interest rates are likely to go down soon at most major central banks around the world. A number of smaller economies, such as Sweden, Switzerland, Hungary, and the Czech Republic, have already cut interest rates.
As of now, it’s not clear if the governing board of the Bank of England will lower the rate from 5.25% when they meet on June 20. Japan’s economy is different from the world’s big economies. After years of below 0 rates and low inflation, Japan has started to raise rates.
Europe’s inflation rate went through the roof when Russia cut off most of the continent’s natural gas sources. As the world economy recovered from the COVID-19 pandemic, there were also delays in getting raw materials and parts to Europe.
The Russian cutoff hurt the eurozone the most, but the energy price spike that followed has mostly gone away. In May, inflation dropped to 2.6%, down from a high of 10.6% in October 2022 and close to the ECB’s goal of 2%.
With more strong growth, government support and COVID recovery spending, as well as higher prices, the Federal Reserve is dealing with a different economy. The U.S. consumer price index is 3.4% a year, which is a long way from the Fed’s goal of 2%.
From the current average level of 5.25% to 5.5%, Fed Chair Jerome Powell has said that the bank plans to cut rates this year. However, there will likely be no change at the Fed’s next policy meeting on June 11th and 12th. As U.S. inflation slowly falls, experts and investors are becoming more and more certain that there will only be one or two cuts this year.
Some people think that making the rate difference between the U.S. and Europe bigger could hurt the euro against the dollar by getting more investment money to leave the eurozone and hold dollars instead, where they can earn more. Imports would cost more, which would hurt the ECB’s fight against inflation.
But the euro has been getting stronger lately—it went from $1.06 in mid-April to around $1.09 now—even though the ECB has been hinting for weeks that rates will be going up.
Rate hikes fight inflation by making it more expensive to borrow money to buy things. This lowers demand, which lessens the pressure on prices. But high rates also slow down growth, and the eurozone economy hasn’t been growing much lately.
For more than a year, economic growth has been just above and below zero. The first three months of the year, when gross domestic product rose 0.3% from the previous quarter, came as a small but welcome surprise.
“While it is noteworthy that the ECB is forging well ahead of the U.S. Fed” said Holger Schmieding, chief economist at Berenberg bank. “the transatlantic difference in inflation and growth more than justifies this, 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 its rate hikes,” Schmieding said. “Seen from this angle, somewhat lower rates make sense.”
Analysts say that the bank will probably not make a lot of more cuts right away after the quarter-point cut on Thursday. This is because the bank wants to make sure that inflation is under control before easing credit to help the economy. The level of inflation in the services sector, which includes things like haircuts, medical care, hotels, restaurants, and event tickets, is still high at 4.1%.
Key interest rates set by central banks are important for everyone, not just investors. Rates affect how much it costs to borrow money across the economy. For consumers, lower rates can mean lower mortgage and credit card costs. Lower interest rates can also raise the prices of stocks and the value of retirement accounts. This is because they lower the profits on safe investments like bank accounts and CDs compared to stocks, which makes buyers want to buy risky stocks.
In Germany, the ECB’s higher rates ended a nine-year rise in home prices and slowed down building, which is very sensitive to changes in the cost of borrowing money. The initial costs of building new green energy production have also gone up because interest rates have gone up. This is because Europe is trying to move away from fossil fuels and fight climate change in line with the 2015 Paris climate agreements.
Bloomberg’s measure of national bond returns went up for the fifth day in a row on Wednesday as investors bet more on monetary easing in countries from the US to Australia. If they keep making gains for six days, it will be the best run since November.
In the past week, traders have increased their bets on rate cuts. This is because a lot of US economic data came in weaker than expected, and the Bank of Canada decided to loosen monetary policy. On Friday, US non-farm payrolls figures will show new signs of whether growth is slowing enough in the world’s largest economy. This will test the excitement about bonds once more.
Deutsche Bank AG’s Asia Pacific chief investment officer, Stefanie Holtze-Jen, said that markets “are at that inflection point now” in terms of demand for bonds. “The minute US data shows more of this weakening growth outlook, that conviction will grow bigger.”
What the European Central Bank does later Thursday will be very important for buyers. According to polls of experts by Bloomberg, the bank will likely cut interest rates. A bad picture for the US economy means that the biggest and most active bond market in the world may not be as bullish as people would like.
A note from Rabobank’s global analyst Michael Every said, “Recent data on the US labor market suddenly looks wobbly. Many in the market are again thinking that ‘rate cuts!’ won the battle of ideas and that the war against inflation is over for good.” “That can be true in some places, and progress will be made.”
Bets on the Market
Swap markets show that buyers think interest rates will go down more often than not for now.
Based on swaps linked to the Federal Reserve’s policy rate, there is a 90% chance of two quarter-point cuts by the end of the year. This is up from 47% at the end of May. Futures buyers think there is a 51% chance that the Reserve Bank of Australia will lower rates by December. Rates were 9% at the end of last month.
This feeling is also spreading to Japan, which is the only other big economy where investors think interest rates on loans will go up. By the end of the year, the price of Bank of Japan rate hikes in swaps had dropped from 29 basis points on May 31 to 23 basis points.
Knowing the right way for rates is more important to investors like State Street Global Advisors than knowing when to cut rates.
“Our core view is that inflation will continue ” Matthew Nest, global head of active fixed income, and Matthew Coolidge, fixed-income portfolio manager, wrote in a report. “allowing the Fed to implement a series of rate cuts that take short-term rates to more appropriate levels,”
