The European Central Bank, with a high probability, has already ended the cycle of monetary policy tightening. As in the previous meeting, the rates did not change on Thursday. The key deposit rate, at which banks can safely deposit excess money with it, remained at four percent.
Similar to the case of the US central bank (Fed), which decided on the stability of interest rates on Wednesday, the discussion now revolves around the timing of the first rate cut. Until now, the ECB has emphasized that interest rates must be kept at higher levels long enough for inflation to fall back to the central bank’s two percent target. And this goal is already in sight.
The inflation rate in the eurozone countries dropped surprisingly significantly in November and reached 2.4 percent, i.e. the lowest value since the summer of 2021. The year-on-year rate of price growth has been falling significantly for three months, which may cast doubt on the central bank’s claim that inflation is still too high.
The belief that the cycle of increasing interest rates has probably already reached its peak is growing in the financial markets.
In addition to falling inflation, this also signals a somewhat shaky performance of the Eurozone economy. It is going through stagnation and teetering on the edge of recession. “Significant headwinds (to economic growth) remain, especially those stemming from massive interest rate hikes,” Bantleon Bank analyst Jörg Angelé told Bloomberg.
The first reduction already in March?
Thus, investors are quite confidently ignoring the conviction of ECB President Christine Lagarde, according to which rates should be at current levels for several quarters. On the other hand, markets are now counting on the scenario that the ECB will cut interest rates by up to 1.5 percentage points next year, while the first easing of monetary policy could come at the March meeting.
However, the central bankers themselves, including some analysts, repeatedly warn against excessive optimism and point out that it is the final phase of the fight against inflation that is the most difficult.
“Investors’ optimism stems from the faster decline in inflation in recent months. Our forecast envisages the first reduction roughly in the middle of next year, given that the ECB itself has so far estimated a return to the inflation target only during 2025,” Raiffeisenbank analysts said.
In the basic scenario, the economists of the ČSOB Group expect the first drop in rates at the July meeting. At the same time, they do not rule out that the ECB will take this step at one of the earlier meetings. “We assess the current market bets as excessive. In summary, the ECB’s deposit rate should fall by one percentage point to three percent in 2024,” they said.
Komerční banka does not expect the first reduction in interest rates until December 2024. “Compared to us, the financial market is far more aggressive when it expects a total drop in rates by around 1.25 percentage points by the end of the year,” sums up KB economist Kevin Tran Nguyen.
The British central bank also held a meeting on Thursday. As expected, it left the base interest rate at 5.25 percent, i.e. the highest level in 15 years. Unlike the US Fed, it announced that interest rates in Britain would remain high for a longer period of time.