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The European Central Bank has sent a clear signal that it will cut interest rates from their historic highs next week, as its chief economist brushed off fears that doing so before the US Federal Reserve could backfire.
The ECB now looks almost certain to be one of the first major central banks to cut rates, having been criticised for being one of the last to raise them after the biggest inflation surge for a generation three years ago.
Philip Lane told the Financial Times in an interview ahead of the bank’s landmark June 6 meeting: “Barring major surprises, at this point in time there is enough in what we see to remove the top level of restriction.”
Investors are betting heavily that the ECB will lower its benchmark deposit rate by a quarter percentage point from its record high of 4 per cent at next week’s meeting after Eurozone inflation fell close to the bank’s 2 per cent target.
The Swiss, Swedish, Czech and Hungarian central banks have already reduced the cost of borrowing this year in response to falling inflation. But among the world’s major economies, the Fed and Bank of England are not expected to cut rates before the summer and the Bank of Japan is considered more likely to continue raising them.
Asked if he was proud that the ECB was in a position to cut rates earlier than others, Lane said: “Central bankers aspire to be as boring and I would hope central bankers aspire to have as little ego as possible.”
He added that a key reason why inflation had fallen faster in the Eurozone than the US was because the region had been hit harder by the energy shock triggered by Russia’s invasion of Ukraine. “Dealing with the war and the energy problem has been costly for Europe,” he said.
“But in terms of that first step [in starting to cut rates] that is a sign that monetary policy has been delivering in making sure that inflation comes down in a timely manner. In that sense, I think we have been successful.”
Lane said ECB policymakers needed to keep rates in restrictive territory this year to ensure that inflation kept easing and did not get stuck above the bank’s target, which he warned “would be very problematic and probably quite painful to eliminate”.
However, he said the pace at which the central bank lowered Eurozone borrowing costs this year would be decided by assessing data to decide “is it proportional, is it safe, within the restrictive zone, to move down”.
“Things will be bumpy and things will be gradual,” said Lane, who is responsible for drafting and presenting the proposed rate decision before it is decided by the 26 members of the governing council next week.
“The best way to frame the debate this year is that we still need to be restrictive all year long,” he added. “But within the zone of restrictiveness we can move down somewhat.”
Lane said in a speech on Monday: “The subsequent pace of rate cuts will be slower if there are upward surprises to underlying inflation . . . and the level of demand” but they will be “faster if there are downward surprises” on inflation and demand. He went on to tell reporters at the Dublin event: “The discussion about a rate cut next week is not a declaration of victory.”
Despite recent data showing Eurozone wage growth picked up to a near-record pace at the start of this year, Lane said “the overall direction of wages still points to deceleration, which is essential”, adding that this was backed up by the ECB’s own wage tracker.
Some analysts have warned that if the ECB diverges from the Fed by cutting rates more aggressively it could cause the euro to depreciate and push up inflation by raising the price of imports into the bloc.
Lane said the ECB would take any “significant” exchange rate move into account, but pointed out “there has been very little movement” in this direction. The euro has rebounded by a fifth against the US dollar from a six-month low in April and it remains up over the past year.
Instead, he said delays in the expected timing of Fed rate cuts had pushed up US bond yields and this had lifted long-term yields of European bonds.
“That mechanism means that for any interest rate we set, you get extra tightening from the US conditions,” he said, indicating the ECB might have to offset this with extra cuts to its short-term deposit rate. “All else being equal, if the long end tightens more, then how you think about the short end changes.”
Eurozone inflation has fallen from above 10 per cent at its peak in 2022 to a near three-year low of 2.4 per cent in April, but it is expected to tick up to 2.5 per cent when data for May comes out this week.
Lane said that the “still significant amount of cost pressure” coming from rapid wage growth pushing up services prices meant that the ECB would have to keep policy restrictive until 2025.
“Next year, with inflation visibly approaching the target, then making sure the interest rate comes down to a level consistent with that target − that will be a different debate,” he said.
How far the ECB cuts rates overall will hinge on its assessment of the so-called neutral rate, the point at which savings and investment are balanced at desired levels, where output is at an economy’s potential and inflation is at target.
Estimates of the neutral rate vary but Lane said it was likely to imply a policy rate at or just above 2 per cent, although this could be higher if “a vigorous green transition” to renewable energy or vast gains from generative artificial intelligence prompted a surge in investment.
Additional reporting by Jude Webber in Dublin
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