Today, the ECB voted to reduce the base rate by 0.25% to 3.75%, making this the first cut since 2019.
This was after the Euro area inflation rate fell to 2.6% in May, higher than the UK’s most recent inflation rate of 2.3% and the US’ rate of 3.4% in April. The US’ inflation rate for May will be published on 12 June.
Yesterday, the Bank of Canada was the first central bank in the G7 to reduce interest rates, with a cut to 4.75%. Earlier this year, Switzerland’s central bank made a reduction from 1.75% to 1.5%, while Sweden’s fell from 4% to 3.75%.
BoE under pressure to cut base rate
Russ Mould, investment director at AJ Bell, said this move brought about the “long-awaited pivot in monetary policy” and signalled “the start of a new era”.
He added: “We’re now beginning the next phase in the cycle where inflationary pressures ease and central banks move to a new playbook to help prop up a flagging economy and make life easier for consumers and businesses who have had to stomach sky-high borrowing costs.
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“The Bank of England and Federal Reserve might give the impression they aren’t swayed by what the ECB and other countries do, but the greater the number of central banks cutting, the more pressure they will be under to do the same.”
Lindsay James, investment strategist at Quilter Investors, said the “starting gun had been fired” by the ECB, adding that this was significant as it was the first cut by the central bank in five years and ended “what has been one of the most aggressive and swift rate-hiking cycles in modern times”.
She added: “Importantly, this is not likely to be a single cut and done for a while, with signals suggesting a further cut or two are on the horizon this year as inflation has subsided. The ECB has stolen a march on the Bank of England and Federal Reserve – who are both potentially still a few months away from cutting – and will breathe life into an economy that desperately needs some form of stimulus.
“This move also focuses eyes on the BoE, who will make its decision in a couple of weeks. The major central banks will not want to diverge too far from one another, and with political risk being ratcheted up, they also won’t want to be seen as too influential.”
Getting the timing right
Ben Nichols, interim managing director of RAW Capital Partners, said: “While the impact of the cut is unlikely to be felt immediately, the move adds to the growing feeling that the global economy has turned a corner, and should provide some impetus to the Eurozone’s business investment, consumer spending and housing markets.”
However, Nichols added: “The risk remains that the ECB is cutting rates too early, and it will be intriguing to see if the US Federal Reserve and Bank of England follow suit in the coming months.”
He said the outlook for energy prices was still “unreliable” and geopolitical conflict could create challenges in the future. Nichols also said the Eurozone’s strong labour market could see inflationary pressures return if rates have been lowered too quickly.
Susannah Streeter, head of money and markets at Hargreaves Lansdown, said the ECB had moved faster than the Bank of England and Federal Reserve, but was “expected to hit the pause button now, as sticky inflation has returned as a worry”.
“While rates went straight up like a rocket, they look likely to descend in bumpy fashion,” Streeter said.
She added: “Financial markets have been pricing in 2-3 rate cuts in total by the ECB by the end of the year, but it’s looking unlikely that policymakers will vote for another move lower next month.
“Caution is set to stay the name of the game, as they await fresh indications about inflation’s path.”
Streeter said the Eurozone’s headline inflation rate “went in the wrong direction” and moved further away from the ECB’s 2% target when it rose from 2.4% in March and April to 2.6% in May.
“However, the overall direction of travel is clear – and it’s downwards. The ECB decision will raise hopes that UK interest rates will also be brought down sooner rather than later. The data coming in over the past few days has been more positive for the Bank of England, indicating that price pressures are easing.
“So an interest rate cut in August is still a very real possibility, although the financial markets have not been fully pricing in a cut until November,” she added.
The Bank of England’s Monetary Policy Committee (MPC) will make its next base rate decision on 20 June.
