European Central Bank (ECB) President Christine Lagarde addresses a press conference following a meeting of the ECB’s Governing Council on April 11, 2024 in Frankfurt am Main, western Germany.
Kirill Kudryavtsev Afp | Good pictures
FRANKFURT – The European Central Bank is set to cut borrowing costs for the euro area this week for the first time since September 2019.
This would mark the official end of the record-breaking hiking cycle that began after the Covid-19 pandemic as inflation rose. But investors’ attention seems to have already shifted to what will happen after the Frankfurt company’s cut this June.
“Judging by the officials’ commentary, there is no question about the wisdom of cutting rates on June 6,” said ECB watchdog Mark Wall with Deutsche Bank.
“Even with the upside surprise in May HICP [harmonized index of consumer prices], the ECB could argue that a cut is consistent with its reaction function. The question is, what comes after June?”
Euro area inflation for May was slightly higher than expected at 2.6% and core inflation at 2.9%. On top of that, negotiated wage growth – a figure closely watched by the ECB – accelerated again to 4.7% in the first quarter after hitting 4.5% in the fourth quarter of 2023.
“Many of these data are skewed by the same effects,” said Holger Schmiding, Berenberg’s chief economist.
“For example. A mild winter boosted Q1 [first quarter] In some countries such as Germany earlier this year, external construction and a one-time increase in real GDP pushed up wages more than usual.”
But while another rate cut in July cannot be ruled out, given recent commentary from ECB policymakers, it seems highly unlikely.
“We see some elements of inflation continuing to prove stronger – especially domestic inflation and especially services,” European Central Bank board member Isabelle Schnabel said in an interview with German public broadcaster ARD on May 16.
“I would caution against moving too quickly because of the risk of cutting interest rates too fast. We must avoid that,” he said.
Next on this bumpy road will be the divergence between the ECB and the US Federal Reserve’s own rate setting “higher in the long run”. This is not an easy task as it can have strong implications for the Euro-Dollar exchange rate, feeding inflation through prices for imported goods and services.
“In 6-12 months, our assumptions suggest that there could be a strong pass-through in inflation if the central bank-ECB policy rate differential rises to historically high levels, FX depreciation, as expected, domestic demand remains strong and profit margins remain high. Short and policy Rates are less restrictive,” explained Mark Wall.
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