The ECB signals the first rate cut in nearly 2 years

While the Fed keeps hemming and hawing on interest rates, the European Central Bank (ECB) hints at a potential cut in June, according to the minutes released on April 4.

At their last policy meeting, ECB officials noted that inflation made "encouraging" progress toward their 2% target, paving the way for a rate cut.

“While it was wise to await incoming data and evidence, the case for considering rate cuts was strengthening,” the ECB said.

Although the ECB is scheduled to meet later this month, making any policy changes in April would be premature, officials said.

Policymakers “would have significantly more data and information by the June meeting, especially on wage dynamics,” the minutes read.

“By contrast, the new information available in time for the April meeting would be much more limited, making it harder to be sufficiently confident about the sustainability of the disinflation process by then.”

The ECB’s signals have been enough to convince 90% of economists in a Reuters poll that the first interest rate cut would come in June.

Economists believe the central bank will move forward with 0.25% quarterly reductions unless the outlook changes.

“We think that the ECB will want to tread carefully, and we confirm our expectation there will be three 25bp rate cuts this year, one per quarter, followed by similar steps next year until a more neutral level is reached, probably in the 2% area,” said Marco Valli, chief European economist at UniCredit.

The ECB’s confidence highlights a tale of two kinds of inflation sweeping major economies.

Two-speed inflation

Eurozone inflation cooled more than expected in March, falling to an annual rate of 2.4%, according to Eurostat data. Core inflation—which excludes volatile energy and food prices—also came in lower than expected.

March’s readings mark a sharp decline in the Eurozone's inflation from its peak of 10.6% in October 2022.

The U.S. has also made notable progress after its CPI peaked at 9.1% in June 2022. But unlike in the Eurozone, U.S. headline inflation is picking back up—with three consecutive months of higher-than-expected readings.

“Inflation in Europe looked worse than in the U.S., as the two regions were on different inflationary cycles,” said Dr. Jeffrey Roach, LPL Financial’s chief economist. “But in recent months, things have changed. Pricing pressures in Europe have eased faster than in the U.S.”

This marks a stark reversal of fortunes, as it was only seven months ago that Europe was said to face a “dirtier inflation fight” than the U.S., according to Reuters.

Although both regions are battling stubborn service inflation, the situation appears to be more complicated in the U.S. where the cost of services increased in January by the most in 12 months.

Economists say this could be the final hurdle the Fed needs to clear before rate cuts are a foregone conclusion.

Are services the final hurdle?

In a positive sign for the Fed, service inflation appears to be turning a corner in early 2024.

ISM’s non-manufacturing PMI—a leading gauge of the services industry—weakened to 51.4 in March from 52.6 the month before. That’s just above the cut-off point of 50, which separates an expanding industry from a contracting one.

“This is a sign that services inflation should continue to fade in coming months, a welcome sign for the Federal Reserve after hotter price readings to start 2024,” said Ben Ayers, senior economist at Nationwide. “Still, with labor conditions strong, the first rate cut may be delayed until the second half of 2024.”

Service inflation is tricky because it’s less sensitive to swings in energy costs. That means lower commodity prices don’t necessarily filter through to the consumer to the same extent as goods.

In the meantime, service inflation remains too “sticky,” said former Dallas Fed president Robert Kaplan in an interview with CNBC.

“They’re expecting continued disinflation on goods,” Kaplan said, referring to the Fed. “The sector I’d be watching, that I’m sure they’re watching, is the service sector where inflation’s been sticky. I don’t think you need to see a lot of improvement, but you need to see the numbers heading in the right direction.”