ECB strikes again – Interest rates lowered again
After the monetary policy shift in June, the European Central Bank is taking further action on Thursday. The key rate falls to 3.5%.
Falling energy prices have pushed the inflation rate in the Eurozone down to 2.2% in August – the lowest level in over three years.
Image: instamatics/Getty Images
In light of the decreasing inflation risk, the ECB has initially relaxed its stance after the interest rate shift in June and loosened monetary policy further. The deposit rate, which is significant for the financial markets and at which banks temporarily park excess funds at the ECB, was cut on Thursday by a quarter percentage point to 3.50%, as expected by the financial markets. At the same time, the currency guardians under ECB President Christine Lagarde leave investors guessing ahead of the next meeting in October about what will happen next: “The ECB Council does not commit in advance to a specific interest rate path.”
According to Lagarde, the interest rate decision was made unanimously. However, the Frenchwoman did not reveal whether there could be another rate cut at the ECB Council’s off-site meeting next month in Ljubljana. Although they are fundamentally on a downward trajectory for interest rates, the ECB has not committed in advance – neither regarding the timing nor the magnitude of the next interest rate step. This depends on the economic data. It is very likely that inflation in September will be low due to statistical base effects regarding energy costs. However, the ECB does not orient its course according to individual data but rather to a “whole series of indicators.”
Falling energy prices pushed the inflation rate down to 2.2% in August – the lowest level in over three years. The ECB experts now assume, as in the June projections, that overall inflation in the Eurozone will be 2.5% this year and drop to 2.2% in 2025. In 2026, it is projected to be 1.9%, which would undershoot the ECB’s target of 2%.
However, experts expect inflation to rise again in the latter part of this year. This is partly due to previous sharp declines in energy prices falling out of the annual rates: “Inflation is then expected to return towards our target value during the second half of next year.”
“Interest rate cut could have been greater”
According to Heiner Herkenhoff, the CEO of the banking association, the ECB should also show sensitivity in the coming months: “This includes counteracting public expectations for rapid successive interest rate cuts.” However, there was quiet criticism of the currency custodians’ decision from the union-affiliated Institute for Macroeconomics and Economic Research (IMK): “Today’s interest rate cut by the ECB was correct, but it could have been greater,” said IMK economist Silke Tober. A reduction of half a percentage point would have been a better signal in her view: “Because while inflation seems to be under control and is likely to be very close to the inflation target next year, the risks for the economy are rising.”
The central bank economists now expect only 0.8% economic growth in the Eurozone for this year. For 2025, a GDP increase of 1.3% and for 2026 of 1.5% is expected. In June, economists had still anticipated 0.9% for 2024, 1.4% for 2025, and 1.6% for 2026. This downward correction is justified by a weaker contribution from domestic demand. “Financing conditions remain restrictive, and the economy is still subdued, reflected in weak private consumption and investment activity,” it said.
ECB aims to reduce market interest rate fluctuations
The main refinancing rate, at which commercial banks can borrow money for a week from the ECB, is reduced by 0.6 points to 3.65% with the latest interest rate decision. The fact that the downward step is larger than that of the deposit rate comes from changes that had already been locked in by the ECB in spring. At that time, it was decided to narrow the gap between the deposit and the main refinancing rate. The ECB aims to create incentives for participation in its weekly lending operations and at the same time limit the scale of market interest rate fluctuations.
Banks in the Eurozone currently hold around three trillion euros in excess liquidity that they park at the ECB. Over time, this is expected to decrease, and banks may increasingly turn to borrow money from the ECB. The narrower interest rate corridor is intended to help the ECB manage market interest rates better.
Initial reactions from economists and financial experts:
Clemens Fuest, Ifo Institute
“The ECB’s interest rate cut is justifiable. In light of declining inflation in recent months and weak economic prospects, a loosening of monetary policy can be justified. However, it should be noted that inflation in the services sector is still above four percent. Thus, inflation risks remain. Further interest rate cuts seem appropriate only if the decline in inflation continues. Immediate impacts on the economy will not occur from this interest rate cut, as it was already priced into the markets.”
Alexander Krüger, Hauck Aufhäuser Lampe
“There is much to suggest that the ECB will stick to cautious interest rate cuts for the time being. This is also because wage growth, relative to productivity development, will be too high for the foreseeable future. Not committing and waiting for the data is a sensible strategy for the ECB.”
Friedrich Heinemann, ZEW Institute:
“This interest rate cut was inevitable. The decisive argument was not even the recent approach of inflation to the two percent limit. However, the increasingly poor growth prospects for Germany have ultimately paved the way for lower interest rates. As growth in the largest economy of the Eurozone has come to a standstill and even a recession is looming here, the way for two to three interest rate cuts by the end of the year has opened up. The failure of the German growth engine weighs on the entire Eurozone and thus also dampens price pressure. The Eurozone could therefore be on course for a hard landing in its exit from inflation, unlike the USA.”
Jörg Krämer, Chief Economist Commerzbank:
“This second interest rate cut by the ECB is risky. Because inflation without the highly fluctuating prices for energy and food has settled significantly above the central bank’s target. In addition, labor costs are rising rapidly. If inflation risks do not decline significantly in the coming months, the ECB must be prepared to suspend the interest rate reduction process. However, that does not seem to be the case. The many doves on the ECB Council appear ready for further loosening of monetary policy, as long as inflation data permit it even somewhat.”
Iris Schöberl, President Central Real Estate Committee (ZIA):
“Today’s interest rate decision by the European Central Bank should encourage the federal government to facilitate investments through its own bold steps. Rising construction costs plus rapidly rising interest burdens have paralyzed investors recently. If the government seizes the momentum of the planned key interest rate cut, it could trigger a building wave – a push in the housing market would finally be realistic again.”
Joachim Schallmayer, Dekabank:
“The cautious interest move credibly signals to the market that the ECB has its medium-term inflation target firmly in sight. More is needed to stimulate the economy than just lower interest rates. The stubbornly high core inflation rates will only move down slowly in the medium term. At the same time, it is important not to unnecessarily dampen demand in an already only modestly growing economy. Today’s interest step is the right decision in this environment. We expect further quarterly cuts of 25 basis points each until a level of about two percent is reached.”
Heiner Herkenhoff, CEO Banking Association (BDB):
“Today’s reduction of the ECB deposit rate to 3.5 percent is appropriate. The inflation rate in the Eurozone was recently at 2.2 percent, very close to the ECB’s inflation target for the first time in three years. Nevertheless, the European monetary guardians cannot switch to ‘relaxation mode’ yet. It will therefore be crucial for the ECB in the coming months to demonstrate the right sensitivity. This also includes countering expectations for rapid successive interest rate cuts in the public domain.”
Silke Tober, IMK Institute:
“Today’s interest rate cut by the ECB was correct, but it could have been greater. A reduction of half a percentage point would have been the better signal. Because while inflation seems to be under control and is likely to be very close to the inflation target next year, the risks for the economy are rising. Further interest steps should follow swiftly, as the still highly restrictive monetary policy is especially weakening investment activity. I expect a key interest rate of three percent by the end of 2024.”
Cyrus De La Rubia, HCOB Bank:
“Another rate adjustment is likely to follow. The ECB is unlikely to act more aggressively as the core inflation rate and also service inflation remain stubbornly high. We expect a resurgence of the core inflation rate to 3.2% in September.”
Michael Heise, HQ Trust:
“Today’s interest rate cut is appropriate for the situation. There will likely be another cut before the end of the year. However, the interest rate path in 2025 will not go down as clearly as the financial markets currently expect.”
Jörg Asmussen, GDV:
“Today’s ECB decision to continue the interest rate reduction path is correct and clearly justified by the current data situation. It is a positive and reassuring signal to the markets. Nevertheless, the ECB should continue to demonstrate sensitivity. On the one hand, there are still high inflation rates in the service sector, so that the inflation rate could prove to be stubbornly high in the future. On the other hand, the ECB should not miss the right timing for further rate adjustments. Today, the ECB, with its 25 basis point reduction, has taken a very good middle ground in my opinion.”
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