ECB delivers hawkish rate cut

As widely signalled, the European Central Bank cuts its policy rate by 0.25 percentage points on Thursday, taking the benchmark deposit rate to 3.75 per cent.

The message was hawkish, with forecasts all but ruling out back-to-back cuts in July. ECB staff revised up their inflation forecasts for 2024 and 2025 even though these assumed fewer rate cuts.

Headline inflation is now forecast to average 2.5 per cent in 2024, solidly above the 2.3 per cent rate projected in the March forecasts. For 2025 the forecasts project inflation of 2.2 per cent, up from 2.0 per cent in March.

Growth forecasts were also revised up. These hawkish forecasts were tempered by 2026 inflation forecasts unchanged from March at the target of 1.9 per cent.

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Growth in unit labour costs was also revised up across the forecast horizon, while productivity growth was revised down in 2025 and 2026. This indicates that the ECB expects more inflationary pressures from the labour market, even as headline wage growth moderates.

The ECB’s updated forecast follows higher than expected inflation data for May. The headline and core rates accelerated to 2.6 and 2.9 per cent respectively, versus 2.4 and 2.7 per cent in in April. Wage growth for the first quarter was also higher than expected.

Lagarde struck a cautious tone throughout the press conference, saying that policymakers “are not pre-committing to a particular rate path”. She also noted that the decision to cut was not unanimous, with one rate setter voting to keep interest rates unchanged.

Given the cautious tone and upward forecast revisions, we believe it is even less likely that the ECB will cut a second time in July. But, as ever, the ECB’s next move will depend on how the data evolves.

Lagarde re-emphasised the ECB’s data dependency and, pushing back against Klaas Knot’s recent pronouncements on the issue, refused to rule out cutting at non-projection meetings, saying that policymakers will take a “meeting-by-meeting approach [in] determining the appropriate level and duration of restriction”.

While we think the ECB is very likely to pause in July, we expect it to deliver another two cuts by the end of this year.