ECB- European Central Bank has indicated that it has room to cut interest rates as inflation slows. However, key policymakers emphasize that the ECB should proceed with caution, even though the direction of future policy changes seems evident. With a rate cut anticipated for June 6, the discussion has now shifted to the timing and speed of subsequent cuts.

Policy Perspectives

French central bank chief François Villeroy de Galhau stated that, barring any surprises, the first rate cut in June is almost certain. However, he advocates for flexibility in future decisions, cautioning against committing to a fixed schedule for subsequent cuts. Villeroy emphasized the importance of taking a meeting-by-meeting and data-driven approach, thereby preserving the ECB’s freedom regarding the timing and pace of rate adjustments.

In contrast, ECB chief economist Philip Lane warned that delaying rate cuts could risk pushing inflation below target, potentially necessitating a rush to cut rates more aggressively later. Lane highlighted the danger of keeping rates overly restrictive for too long, which could force the ECB to take corrective actions that might even require lowering rates below neutral levels.

Market Expectations and Projections

Market sentiment has shifted, with expectations now pointing to only one more rate cut this year after the initial move in June. This is a significant reversal from earlier in the year, when up to six cuts were anticipated. Despite this, Lane remains confident that disinflation is on track, with the ECB’s projections indicating that inflation will return to the 2% target by 2025, even if monthly price growth figures are volatile in the near term.

Villeroy expressed that the current market expectations for the ECB’s terminal rate, which is now at 4%, are reasonable, suggesting that it could settle around 2%. He underscored the significant room the ECB has for rate cuts, provided the economic data supports such moves.

Wage Growth and Inflation

Both Villeroy and Lane noted that the recent rise in negotiated wage growth is not particularly concerning. Lane expects a further deceleration in earnings, although he cautioned that this adjustment will be gradual. He explained that deceleration does not necessarily mean an immediate return to a steady state, indicating that the process will unfold over time.

Conclusion

As the ECB prepares for its anticipated rate cut in June, policymakers stress the importance of a cautious and flexible approach to future rate adjustments. While there is room for further cuts, the ECB aims to avoid premature actions that could destabilize inflation targets. The focus remains on data-driven decisions, ensuring that the path of rate cuts aligns with the broader goal of maintaining economic stability and achieving the inflation target by 2025.