European Central Bank Announces Initial Rate Cut, but Future Reductions Will Likely Be Gradual

Today’s decision didn’t come as much of a surprise. After all, the ECB had been telegraphing it pretty clearly. Instead, everyone was looking for clues about the future pace of rate cuts. The ECB was pretty vague on this point, suggesting a very gradual reduction in key rates for the rest of the year.

Inflation has come down sharply from its 2022 peak, enough to start moderating the degree of monetary policy restriction. But inflation is still above target, and there are still troubling signs, including stubbornly high domestic price pressures. Wage growth in particular remains historically strong and could keep inflation above target (graph). Inflation projections were revised higher for both 2024 and 2025, but the ECB expects domestic price pressures—including wages—to ease this year, in part because monetary policy will remain restrictive even after today’s cut. The economy is improving but remains weak, keeping a lid on prices. The ECB also seems reassured by the fact that companies are absorbing wage increases by cutting profits rather than raising prices.

With today’s move, the ECB enters a new rate cutting cycle alongside the Swiss National Bank, the Bank of Sweden and the Bank of Canada. This is great news for borrowers and the economic outlook, but the road to monetary policy normalization will be long and winding. As ECB President Christine Lagarde said, there will be bumps on the road. Disinflation is unlikely to be linear, and we may see worrisome signs along the way. We therefore remain of the view that key rates will come down gradually in the eurozone, at a pace of about 25 basis points per quarter.