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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, with its chief economist dismissing fears that this would happen before the US Federal Reserve could backfire.
It now looks almost certain that the ECB will be one of the first major central banks to cut rates, after being criticized for being one of the last to raise rates following the biggest rise in inflation in a generation three years past.
Philip Lane told the Financial Times in an interview ahead of the bank’s key meeting on June 6: “Barring any major surprises, there is enough in what we are seeing at the moment to lift the highest level of restrictions.”
Investors are betting the ECB will cut deposit rates by a quarter of a percentage point from a record high of 4 percent at next week’s meeting, after euro zone inflation fell close to the bank’s 2 percent target.
The Swiss, Swedish, Czech and Hungarian central banks have cut borrowing costs 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 likely to continue raising rates.
Asked whether he was proud that the ECB was in a position to cut rates earlier than others, Lane said: “Central bankers strive to be as boring as possible and I hope that central bankers strive to have as little ego as possible to have.”
He added that a key reason why inflation in the eurozone had fallen faster than in the US was that the region had been hit harder by the energy shock caused by Russia’s invasion of Ukraine. “Tackling the war and the energy problem has cost Europe a lot of money,” he said.
“But about that first step [in starting to cut rates] that is a sign that monetary policy has delivered results in guaranteeing that inflation will come down in a timely manner. In that sense I think we have been successful.”
Lane said ECB policymakers needed to keep interest rates in restrictive territory this year to ensure inflation continued to decline and not rise above the bank’s target. He warned that this would be “very problematic and probably quite painful to eliminate”.
However, he said the pace at which the central bank would cut euro zone borrowing costs this year would be determined by assessing data to decide “is it proportionate, is it safe to go down within the restrictive zone”.
“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 board’s 26 members next week.
“The best way to frame the debate this year is that we need to be restrictive all year round,” he added. “But within the restrictive zone we can go down a little.”
Lane said in a speech on Monday: “The subsequent pace of rate cuts will be slower if there are upside surprises to underlying inflation. . . and the level of demand,” but these will be “faster if there are downside surprises” in inflation and demand. He then told reporters at the event in Dublin: “The discussion about a rate cut next week is not a declaration of victory.”
Despite recent data showing wage growth in the eurozone rose to a near-record pace early this year, Lane said that “the overall direction of wages still points to a slowdown, which is essential”, adding that this was supported by the ECB’s own figures. salary 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 into account any “significant” exchange rate movement, but pointed out that there has been “very little movement” in this direction. The euro has recovered by a fifth against the US dollar after hitting a six-month low in April and continues to rise over the past year.
Instead, he said delays in the expected timing of the Fed’s rate cuts had pushed up US bond yields, pushing up long-term European bond yields.
“That mechanism means that for every rate we set, you get additional tightening of US conditions,” he said, hinting that the ECB may have to offset this with additional cuts in short-term deposit rates. “All else being equal, the way you think about the short end changes as the long end tightens.”
Inflation in the eurozone has fallen from more than 10 percent at its peak in 2022 to a near three-year low of 2.4 percent in April, but is expected to rise to 2.5 percent when data for May is released this week.
Lane said “still significant cost pressures” from rapid wage growth, which pushed up services prices, meant the ECB would have to keep policy restrictive until 2025.
“Next year, when inflation is visibly approaching the target, and then ensuring that interest rates fall to a level consistent with that target – that will be a different debate,” he said.
The extent to which the ECB cuts interest rates overall will depend on its assessment of the so-called neutral interest rate, the point at which savings and investment are in equilibrium at the desired level, where production is at the level of the economy’s potential and inflation is at target.
Estimates of the neutral rate vary, but Lane said this would likely imply a policy rate at or just above 2 percent, although this could be higher if “a strong green transition” to renewable energy or huge profits from generative artificial intelligence lead to would cause a wave. of investments.
Additional reporting by Jude Webber in Dublin