What the turnaround in ECB interest rates means for the economy and the euro

The European Central Bank (ECB) has done what many borrowers have been waiting for: it has cut interest rates for the first time since 2019, by 0.25 percentage points. ECB President Christine Lagarde and other council members emphasized that future interest rate moves would be data-dependent, which calmed the markets. Whether there will be another rate cut this year remains uncertain.

The decision to lower rates marks a significant shift in interest rates in the Eurozone, initiating a looser monetary policy after a period of rapid rate hikes from 2022 to 2023. Following the rate cut, the main refinancing rate and the deposit rate are now at 4.25% and 3.75%, respectively. This change was anticipated by financial markets, as the ECB had been sending clear signals in recent weeks. The decision to lower rates is based on an updated assessment of inflation prospects and economic dynamics. Despite declining, inflation remains persistently above the 2% target. The ECB forecasts an average inflation rate of 2.5% for 2024, 2.2% for 2025, and 1.9% for 2026, slightly revising previous projections upward. Despite these higher expectations, the ECB sees the need to reduce monetary restraint to support economic growth.

For savers, the rate cut means that the era of high savings interest rates is slowly coming to an end. This could lead to more money flowing into higher-yielding investments or an increase in consumption, aiming to boost demand in the weak Eurozone economy. For borrowers, especially in mortgages and car loans, the rate cut is good news. More favorable financing makes the purchase of such goods more attractive and should stimulate the real estate and automotive sectors.

Europe is different

The ECB is not revealing its hand regarding future interest rate moves. Lagarde emphasized that the central bank will make decisions from meeting to meeting based on the latest economic data. While some members of the ECB council are advocating for another rate cut as early as July, others want to take more time. The markets are currently expecting one to two more 0.25 percentage point rate cuts by the end of the year.

In the past 25 years, the ECB has only changed interest rates once before the Fed. In the spring of 2011, when the financial crisis seemed to have been overcome, the ECB unexpectedly initiated a cycle of interest rate hikes. However, the start of the Eurozone crisis quickly forced the central bank to reverse course. The current interest rate cycle is different: the US economy experienced dynamic growth in 2023 and is expected to do so in 2024, along with persistently high inflation. In contrast, the Eurozone economy has stagnated due to various crises such as the energy crisis, with growth rates of only 0.4% in 2023 and an expected 0.7% in 2024. At the same time, the trend in inflation in the Eurozone is downward. In this context, it is quite appropriate for the ECB to cut interest rates ahead of the US central bank.

Limited economic stimulus

The euro is likely to be the victim of this development, potentially losing further value against the USD. However, this could provide much-needed support to the Eurozone economy by making exports more competitive and thus promoting economic growth.

The ECB’s rate cut marks a turning point in Eurozone monetary policy, bringing both opportunities and challenges. Savers must prepare for lower deposit rates, while borrowers can benefit from more favorable financing conditions.

The ECB has just loosened the reins and is cautiously starting to step on the gas pedal. This initial movement marks the beginning of a journey that still needs to gain momentum significantly to effectively boost the economy.

This information is a marketing communication from Kathrein Privatbank Aktiengesellschaft. It does not contain any direct or indirect recommendation for the purchase or sale of financial instruments or an investment strategy. When investing in financial instruments, price fluctuations due to market changes are possible at any time. Representations of past performance do not provide reliable conclusions about future results. Despite careful research and data collection, no liability or guarantee can be assumed for the accuracy of the data.