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European Central Bank Cuts Interest Rates, Signaling Policy Shift Amid Improved Inflation Outlook

The European Central Bank (ECB) made a significant policy shift on Thursday, lowering interest rates for the first time in nearly five years. This move marks a departure from the bank’s aggressive efforts to combat inflation, as officials aim to support economic growth in the eurozone.

A Welcome Change in Inflation Dynamics

With inflation easing towards the ECB’s 2 percent target, the central bank decided to cut its three key interest rates by a quarter-point. This adjustment affects all 20 countries using the euro. The benchmark deposit rate was reduced to 3.75 percent from 4 percent, a historic high since September.

Christine Lagarde, the ECB President, emphasized the improved inflation outlook in a news conference in Frankfurt. “The inflation outlook has improved markedly,” she stated. “It is now appropriate to moderate the degree of monetary policy restriction.”

Global Trend Towards Easing Monetary Policy

The ECB’s rate cut aligns with a broader global trend, where policymakers recognize that high interest rates have effectively curbed inflation. Now, central banks are starting to lower rates, offering relief to businesses and households by making loans more affordable. The Bank of Canada recently led this movement among the Group of 7 nations, with similar actions taken by central banks in Switzerland and Sweden.
However, the United States remains cautious. Federal Reserve officials are holding off on easing policy until they are more confident about the end of persistent inflation. The Bank of England, on the other hand, signals potential rate cuts by summer.

Europe’s Inflation Crisis: A Retrospective

The ECB’s recent rate cut, the first since September 2019, signals that the worst of Europe’s inflation crisis is over. In late 2022, eurozone inflation soared above 10 percent due to rising energy prices, affecting consumer goods and services and leading to higher wage demands. To counter this, the ECB embarked on an aggressive rate hike cycle, pushing the deposit rate to 4 percent from negative 0.5 percent within a year.
This strategy succeeded in reducing inflation, which dropped to 2.6 percent in May. Lower energy prices have significantly contributed to this decline, with food inflation also slowing to below 3 percent from over 12 percent a year ago.

The Road Ahead: Balancing Act and Caution

While the ECB’s rate cut was welcomed, it was accompanied by caution. The bank warned of persistent strong price pressures, projecting that inflation would stay above the 2 percent target well into next year. The overall inflation rate is expected to average 2.2 percent in 2025, slightly higher than earlier forecasts.

Lagarde highlighted the uncertainty surrounding the inflation outlook, stressing that price growth might fluctuate throughout the year. The ECB remains vigilant about wage growth, which could lead to higher consumer prices if businesses pass on increased labor costs.

Despite this cautious stance, the ECB’s staff forecasted economic growth in the eurozone at 0.9 percent for this year, up from 0.6 percent three months ago. The services sector is expanding, manufacturing is stabilizing, and exports are expected to grow as global demand increases. Additionally, lower inflation and higher wages are expected to boost consumer spending power.