ECB Lowers Rates to Boost EU Economies
On 17 October, the ECB cut interest rates for the third time this year, as inflation in the EU slows down even faster than anticipated. This was announced from Ljubljana by the President of the European Central Bank, Christine Lagarde. As previously mentioned, price growth in the eurozone slowed to 1.8% in September, which is below the target rate of 2%. As The Gaze forecast at the start of September, inflation signalled a reduction in interest rates by October. The ECB’s decision was anticipated by the market: while on 30 September the euro-dollar exchange rate was at $1.1196, on the eve of the decision, it had dropped to $1.0897 as of 16 October. Virtually all commentary had also predicted a rate cut.
The first decision to reduce interest rates by the European Central Bank occurred in June, following a lengthy period of rate increases. In July, they took a pause, as the inflation situation had not improved as much as expected. Finally, on 12 September, the ECB Governing Council made its second decision to lower key interest rates, reducing the deposit rate from 3.75% to 3.5%. This rate is the primary tool used by the ECB Governing Council to manage monetary policy.
Economic Recovery Takes Priority
On 17 October, the ECB Governing Council decided to lower the deposit rate further from 3.5% to 3.25%. The basis for this reduction was, of course, the slowdown in inflation to 1.8% as of September. This is even better than the desired target, which ECB officials have consistently referred to – 2% annually. But another reason is to support the acceleration of economic recovery in EU countries following the effects of the COVID-19 pandemic. Indeed, after the extreme inflation of the previous two years – 2022 and 2023 – the ECB, like other central banks, was forced to significantly raise rates to slow price increases.
However, the consequence of these decisions has not only been curbed inflation but also a slowing of the economy. This is the unfortunate side effect of battling inflation. It is a well-known fact that when inflation accelerates, central banks raise the key interest rate. But, as already noted, the result of raising rates is slower economic growth and reduced employment. As soon as central banks see the opportunity to return to lower rates, they aim to do so as quickly as possible to support stable economic growth.
It is worth recalling that last month, the ECB revised its growth forecast for the eurozone for 2024, now predicting GDP growth of 0.8% compared to the previous forecast of 0.9%. Some of the largest economies in the eurozone continue to face serious challenges, including weak industrial output in Germany and the large-scale fiscal consolidation project being prepared in France. It seems that Berlin and Paris will coordinate their actions, but they also need support from the ECB.
It is possible that inflation may accelerate slightly by the end of October, but the need for economic recovery appears to take precedence in ECB decisions over concerns about a temporary increase in inflation. The next ECB decision on rates is expected on 12 December.
What’s Happening Around
When we hear about changes in interest rates, we must understand that these changes will affect almost everything: prices, job availability, wage growth rates, and the value of national currencies relative to others. The current ECB rate reduction has already been reflected in the nearly three-week trend of the euro weakening against the US dollar. But if the US Federal Reserve cuts its rates again, the euro may strengthen slightly against the dollar.
As a reminder, the US Federal Reserve (Fed) sharply lowered interest rates in mid-September by half a percentage point, so the current Fed rate now stands at 4.75-5%, down from 5.25-5.5% earlier. Following that cut, markets reacted almost unanimously: the euro, oil, and stocks rose, while gold became slightly cheaper. However, we remember that gold had hit record highs just before this. It is worth noting that the Fed’s rate cut in September was the first in four years.
Fed Chairman Jerome Powell promised further rate cuts month ago, conditions permitting – specifically, if prices continue to slow down in future. The next Fed meeting is scheduled for the week after 5 November, immediately following the main voting day in the US presidential election. The likelihood of a Fed rate cut is quite high, but it will probably be by a quarter of a percentage point, rather than by half as in September. December is still uncertain. It is quite likely that by the end of the year, we will see US interest rates at 4.25-4.5%.