Unless there is a last-minute surprise, the European Central Bank (ECB) is expected to cut its key rates by 25 basis points at its monetary policy meeting scheduled for this Thursday 5 June. Interest rate markets are anticipating this cut with a high degree of probability. By doing so, the ECB would position its deposit rate in the middle of the neutral range estimated at between 1.75% and 2.25%.
This further rate cut is justified not only by recent inflation trends, but also by the latest economic activity figures. Although May’s inflation figures will not be released until 3 June, they are expected to be down compared to April’s figures and closer to the ECB’s 2% inflation target. In April, the figures exceeded expectations due to underlying inflation fuelled by the rise in service prices, benefiting from a temporary effect linked to the Easter holidays. As with the latest French inflation figures, already available for May, inflationary pressures are likely to be less pronounced in the eurozone.
In the short term, inflationary pressures are likely to remain on the downside for a number of reasons: tariffs, the strengthening of the single currency, falling energy costs and slowing wage growth. These developments should therefore enable the ECB to achieve its inflation target, and perhaps even more quickly than previously anticipated. This should be reflected in the new economic projections, which will also be released on Thursday 5 June.
To the rescue of economic activity
As previously indicated, the rate cut planned for this Thursday is also justified by the weakness of economic activity in the eurozone. Although first-quarter GDP figures showed the eurozone to be surprisingly resilient in an uncertain international environment, the latest PMI indices point to a weakening in activity, particularly in the services sector. By cutting rates once again, the ECB is aiming to support a struggling economy, characterised mainly by weak investment.
Whilst this latest rate cut seems more or less to have been implemented, the governors of the European Central Bank are carefully assessing the future direction of monetary policy. An analysis of recent speeches by ECB members reveals divergent opinions. Some are in favour of continuing the easing cycle, fearing that current developments could cause inflation to fall below the target set by the institution. Others believe that it is essential to take account of the medium- and long-term effects. As ECB executive board member Isabel Schnabel recently explained, tariffs could further increase tensions in supply chains, leading to higher production costs and, consequently, inflationary pressure in the eurozone. In addition, the effects of expansionary fiscal policies, particularly in infrastructure and defence, desired by several eurozone countries, including Germany, must also be taken into account.
It is difficult to predict which side will ultimately prevail. What is certain is that the ECB is faced with a dilemma. The economic projections updated on 5 June will be crucial, as will the trend in economic indicators. Only the trend in the latter will determine which side is right. A pause in the rate-cutting cycle remains possible after the June meeting, but this does not mean that a further cut between now and the end of the year is out of the question. Financial markets are currently forecasting a further 25 basis point cut from September, following the June cut.
*William Telkes is chief economist at the Spuerkeess.
This article was originally published in French.
