Eurozone Lowers Interest Rate for the First Time in Five Years

The EU has become the second major global economy to reduce its lending rate this week, citing progress in addressing inflation. The European Central Bank (ECB) announced a cut in its main interest rate from a record high of 4% to 3.75%, following Canada’s decision on Wednesday to lower its official lending rate.

This rate cut coincides with EU-wide elections over the next four days, where voters are expected to express their dissatisfaction with cost-of-living pressures. ECB President Christine Lagarde stated that the inflation outlook had “markedly” improved, enabling the rate reduction. However, she cautioned that inflation is likely to remain above the bank’s 2% target “well into next year,” with forecasts averaging 2.5% in 2024 and 2.2% in 2025. Lagarde emphasized that the ECB would maintain a “sufficiently restrictive” interest rate policy as long as necessary to achieve the 2% target but did not commit to a specific rate path.

Lindsay James, investment strategist at Quilter Investors, noted that while the rate cut was anticipated, it would still bring relief to consumers and businesses across the continent. “The ECB has stolen a march on the Bank of England and [US] Federal Reserve, who are both potentially still a few months away from cutting rates, and will breathe life into an economy that desperately needs some form of stimulus,” she said.

Central banks have kept rates high for the past two years to curb rising prices, with most targeting an annual inflation rate of 2%. However, higher interest rates tend to slow economic growth. Lowering interest rates should stimulate economic activity by making borrowing cheaper for consumers and businesses.

Meeting in Frankfurt on Thursday, the EU’s rate-setting body decided to cut rates despite a slight increase in inflation in May, which rose to 2.6% from 2.4% in April across the 27-nation bloc. The ECB’s decision followed Canada’s rate cut on Wednesday, which reduced its headline rate from 5% to 4.75% after inflation there fell to 2.7%. Sweden and Switzerland have also trimmed their rates.

Ms. Lagarde provided a broader assessment of the eurozone’s economic outlook, expressing increased confidence in the future trajectory while acknowledging potential “bumps in the road.” She cited geopolitical tensions in Ukraine and the Middle East, as well as climate-related issues, as potential risks to economic growth.

Katherine Neiss, chief European economist at investment firm PGIM, expressed confidence that the ECB would further cut rates over the summer or autumn, potentially bringing eurozone rates to 3.5% or lower by the end of the year. She noted that while growth is recovering from last year’s recession, it remains sluggish. This, combined with slowing inflation and easing wage growth, would justify additional rate cuts, she told the BBC’s Today Programme.