ECB: What do the first interest rate cuts since 2019 mean?

Following an unprecedented series of key interest rate hikes to fight inflation, the European Central Bank (ECB) has lowered its interest rates in the eurozone. This is the first rate cut since 2019. As the ECB Governing Council announced, the central bank’s key rate was reduced by 0.25 percentage points to 3.75%. The move by the ECB to cut interest rates was widely-anticipated.

“From the perspective of the banks, a single interest rate cut of 25 basis points will not improve the mood of companies and households. Credit growth in the eurozone remains anaemic at best, after months of stagnant or negative lending. Only a long easing cycle (100-125 basis points) over the next 18 months can contribute to a recovery in lending and support banks’ lending income,” commented Filippo Alloatti, Head of Financials – Credit at Federated Hermes Limited.

Inflation in the eurozone has not yet been conquered. In May, the inflation rate came in at 2.6%, and the ECB, at the meeting on June 6, raised its annual average headline inflation outlook for this year to 2.5% from 2.3% previously.

“The question today is how long it will take for inflation to return to 2%,” said Patrick Barbe, Head of European Investment Grade Fixed Income at Neuberger Berman. “A key interest rate of 4% seems a little too restrictive for the eurozone, which justifies the initial cut on Thursday. The ECB should remain cautious and data-dependent in its future interest rate policy. We therefore assume that the ECB will maintain its restrictive policy this year, albeit to a lesser extent and with the key interest rate lowered to 3%. As a result, euro bonds should perform better and the interest rate for 10-year German government bonds should fall below 2.25 %,” Barbe opined.

“The ECB may push back on any set cadence of cuts, repeating comments from previous press conferences that it will take a data-dependent approach to policy rates,” said Ian Horn, Portfolio Manager at Muzinich & Co. “We would see this as positive for European spreads at the front end, but it may put pressure on longer-dated spreads, a recent trend exacerbated by a rise in long-dated euro issuance.”