The European Central Bank sent a clear signal that it will cut interest rates from their record highs next week, as its chief economist dismissed fears it would do so before the US central bank could have a negative impact.
The ECB now looks set to be one of the first major central banks to cut rates, having been criticized for being one of the last to raise them after the biggest rise in inflation in a generation three years ago.
Philip Lane told the Financial Times in an interview ahead of the bank’s landmark meeting on June 6: “Barring any major surprises, there is enough in what we see at the moment to remove the highest level of restrictions.”
Investors are betting heavily on the ECB to cut its benchmark deposit rate by a quarter of a percentage point from a record 4 percent at a meeting next week after eurozone inflation fell close to the bank’s 2 percent target.
The Swiss, Swedish, Czech and Hungarian central banks have reduced borrowing costs this year in response to falling inflation. But among the world’s biggest economies, the Fed and the Bank of England are not expected to cut rates before the summer, and the Bank of Japan is seen as more likely to continue raising them.
Asked if he was proud that the ECB was in a position to cut rates earlier than others, Lane said: “Central bankers want to be as boring as possible and I hope central bankers tend to have as little ego as possible.”
He added that a key reason why inflation fell faster in the eurozone than in the US was that the region was hit harder by the energy shock caused by Russia’s invasion of Ukraine. “Dealing with the war and the energy problem was expensive for Europe,” he said.
“But in terms of that first step [in starting to cut rates] it is a sign that monetary policy has produced results in ensuring that inflation is reduced in a timely manner. In that sense, I think we succeeded.”
Lane said ECB policymakers needed to keep rates in restrictive territory this year to ensure inflation continued to ease and did not get stuck above the bank’s target, which he warned “would be very problematic and probably quite painful to eliminate”.
However, he said that the pace at which the central bank has reduced the borrowing costs of the eurozone this year will be decided by evaluating the data to decide “whether it is proportional, whether it is safe, within the restrictive zone, to move downward”.
“Things are going to be tricky and things are going to happen gradually,” said Lane, who is responsible for drafting and presenting the proposed rate decision before the 26-member governing council decides on it next week.
“The best way to frame the debate this year is that we still have to be restrictive throughout the year,” he added. “But within the restrictive zone we can move down a bit.”
In a speech on Monday, Lane said: “The further pace of rate cuts will be slower if there are surprises to growth in core inflation . . . and the level of demand,” but will be “faster if there are surprises” to inflation and demand. He then said to reporters at an event in Dublin: “Debating a rate cut next week is not declaring victory.”
Despite recent data showing eurozone wage growth rose to a near-record pace earlier this year, Lane said “the overall direction of wages still points to a slowdown, which is important,” adding that this was supported by ECB data. companion pays.
Some analysts have warned that if the ECB moves away from the Fed by cutting rates more aggressively, it could cause the euro to depreciate and fuel inflation by raising the price of imports into the bloc.
Lane said the ECB would take into account any “significant” move in the exchange rate, but noted that “there has been very little movement” in that direction. The euro has recovered by a fifth against the US dollar from a six-month low in April and has remained on the rise over the past year.
Instead, he said the delay in the expected timing of the Fed’s rate cut has pushed up US bond yields, which has lifted long-term European bond yields.
“That mechanism means that for whatever interest rate we set, you get an additional tightening of US conditions,” he said, indicating that the ECB may have to offset this with additional cuts to its short-term deposit rate. “All else being equal, if the long end gets tighter, then the way you think about the short end changes.”
Eurozone inflation fell from above 10 percent at its peak in 2022 to a nearly three-year low of 2.4 percent in April, but is expected to rise to 2.5 percent when May data comes out this week.
Lane said “still significant cost pressures” coming from rapid wage growth pushing up service prices meant the ECB would need to maintain a restrictive policy until 2025.
“Next year, with inflation visibly approaching the target, and then making sure that the interest rate comes down to a level that is consistent with that target – that will be a different discussion,” he said.
How much the ECB cuts rates overall will depend on its assessment of the so-called neutral rate, the point where savings and investment are balanced at desired levels, where output is at the economy’s potential and inflation is at the target level.
Estimates of the neutral rate vary, but Lane said it would likely mean a policy rate at or just above 2 percent, although it could be higher if a “strong green transition” to renewable energy or big gains from generative artificial intelligence fuel a wave of investment.
Additional reporting by Jude Webber in Dublin
