ECB cuts rates for first time in 5 years, but there’s a catch

For the first time in five years, the European Central Bank (ECB) voted to lower its benchmark interest rate—only to throw a curveball with an unexpected remark.

In a move that was widely expected, the ECB slashed interest rates by a quarter point to 3.75% and signaled it was open to further adjustments depending on how the economy reacts.

What was less expected was the ECB staff’s revised outlook on inflation. Now, ECB officials predict headline inflation to average 2.5% in 2024, higher than their previous estimate of 2.3%.

That means central bankers are still worried about inflation but decided to cut rates anyway.

ECB President Christine Lagarde warned that progress on inflation would be “bumpy” and that headline CPI probably wouldn’t reach its 2% target until 2026.

“Despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year,” Lagarde said in a press conference.

Early estimates showed that Eurozone inflation accelerated to 2.6% annually in May, compared to 2.4% the previous month. Core inflation, which excludes volatile food and energy prices, likely rose to 2.9% from 2.7% in April.

Sticky inflation, combined with the ECB’s mixed messages, has economists questioning the logic of lowering interest rates now.

For the ECB, this was just one small step in easing the growing financial burden facing borrowers.

ECB joins Canada in lowering rates

The ECB isn’t even the first central bank to lower interest rates this week.

On June 5, the Bank of Canada became the first G7 monetary authority to cut rates. Like in Europe, Canada has made notable progress on inflation, even though cost pressures remain uncomfortably high.

“We’ve come a long way in the fight against inflation,” said Bank of Canada Governor Tiff Macklem. “Our confidence that inflation will continue to move closer to the 2% target has increased in recent months.”

Meanwhile, central banks in Sweden and Switzerland have already cut rates this year.

The reason the Federal Reserve is falling behind is that it's grappling with the surprising comeback of inflation—with headline inflation rising for three consecutive months.

Coupled with lower economic growth in the first quarter, rising inflation led some economists to voice concern over the risk of "stagflation."

Although Fed Chair Jerome Powell has laughed off stagflation fears, he’s adopted what he calls a wait-and-see mode regarding interest rates.

That’s a far cry from just a few months ago when the Fed penciled in three rate cuts this year.

The Fed's benchmark rates have a more profound effect on global markets, influencing everything from sovereign debt markets to currencies.