Key Takeaways
On Thursday, Oct. 17, 2024, the European Central Bank (ECB) lowered its key interest rates by 0.25% as anticipated, signaling a continued easing of monetary policy.
Despite a recent decline in inflation, the ECB maintained a cautious outlook, emphasizing the need for restrictive rates to ensure price stability. But now, some policymakers fear that inflation is slowing too rapidly.
European Central Bank President Christine Lagarde has indicated that inflation in the Eurozone may decrease more rapidly than previously anticipated, bolstering the case for further interest rate reductions.
Lagarde expressed confidence that the ECB’s target inflation rate of 2% would be reached sustainably by the end of 2025. She even hinted at the possibility of an earlier achievement.
While acknowledging the need for caution, Lagarde emphasized that the direction of monetary policy is clear. Incoming economic data will determine the pace of future rate cuts.
When asked about the ultimate destination for interest rates, Lagarde avoided providing a specific target. She noted that the neutral interest rate, which neither stimulates nor slows the economy, is likely higher than in the past but remains below the current level.”
“So if you were to ask me today, ‘Where is it?’, the honest answer is, I don’t know,” Lagarde said.
However, slowing inflation is now a worrying issue for Lagarde’s colleagues at the ECB. Policymakers have expressed growing concerns about the risk of inflation falling below the central bank’s target of 2%. This marks a significant shift in focus after years of grappling with excessive price growth.
Central bank governors from France, Portugal, and Finland have argued that the current economic weakness and the ECB’s ongoing monetary tightening could lead to deflationary pressures. Their comments reinforce market expectations for continued interest rate cuts.
Francois Villeroy de Galhau, the head of the French central bank, emphasized the importance of “agile pragmatism” to avoid falling behind the curve with rate cuts. Mario Centeno, the Portuguese central bank governor, echoed this sentiment, highlighting the increased risk of inflation undershooting the target.
Olli Rehn, Finland’s central bank chief, also acknowledged the potential for disinflationary pressures due to the weakening economic outlook. The eurozone economy has been struggling with stagnation for nearly two years, raising concerns about structural weaknesses and a delayed recovery.
While ECB President Christine Lagarde remains optimistic about inflation returning to the target, she acknowledged the potential for a faster decline than anticipated.
The decision brings the deposit facility rate to 3.25%, the primary refinancing operations rate to 3.40%, and the marginal lending facility rate to 3.65%.
While the market had widely expected this move, the ECB’s guidance on future policy adjustments remained ambiguous, leaving investors uncertain about the pace of future rate cuts.
Policymakers reiterated the bank’s “data-dependent and meeting-by-meeting” approach to monetary policy.
“The Governing Council is not pre-committing to a particular rate path,” the statement said, matching the language of September’s decision.
After enacting 450 basis points—4.5 percentage points—worth of interest rate hikes during the cycle, the ECB made its first 25bp cut in June. It then kept rates on hold in July.
Eurozone inflation eased slightly in September, according to recent data . Eurostat data showed that harmonized consumer prices rose 1.8% year-on-year, falling just below the 1.9% market consensus. This marks a decline from the 2.2% annual increase recorded in August.
Month-on-month, prices dipped 0.1% in September after a 0.1% rise in August. Core inflation, which excludes energy, food, alcohol, and tobacco, came in at 2.7% annually, slightly below expectations of it remaining unchanged at August’s 2.8%.
Core prices continued their upward trend on a monthly basis, increasing by 0.1% in September, following a 0.3% rise in August. Services saw the highest annual inflation rate at 4.0%, down marginally from 4.1% in August, Eurostat reported.
European Central Bank President Christine Lagarde expressed optimism regarding the recent economic developments, stating that they reinforce her belief that inflation will soon return to the bank’s target of two percent. Speaking at a European Parliament hearing, she noted that recent indicators bolster confidence that inflation will reach this target in a timely manner.
German data released on Monday indicated that inflation stood at 1.6% in September, although an increase is anticipated later in the year. Similarly, France and Spain reported inflation rates below the ECB’s target, with figures at 1.2% and 1.5%, respectively.
Analysts surveyed by FactSet expect the Eurozone’s inflation figure for September to be released on Tuesday, predicting a reading of 1.8%, down from 2.2% in August. Lagarde mentioned that a September inflation rate below two percent would fall short of the baseline forecasts made by ECB economists.
She highlighted that this trend demonstrates the bank’s progress in combating inflation and signals that a disinflationary process is underway, although she cautioned that inflation rates may rise again in the coming months. In its latest projections, the ECB anticipates that inflation in the Eurozone will stabilize at two percent by the end of 2025.
Should inflation trends continue to indicate a return to the two percent target, it could pave the way for ECB policymakers to consider further interest rate cuts. Lagarde confirmed that the upcoming inflation data will be taken into account during the next monetary policy meeting in October.
The ECB said that another rate cut was “appropriate” based on the Governing Council’s “updated assessment of the inflation outlook, underlying inflation dynamics, and the effectiveness of monetary policy transmission.”
The bank noted that recent inflation data had aligned with expectations and reaffirmed its June inflation forecast, projecting a headline rate of 2.5% in 2024, 2.2% in 2025, and 1.9% in 2026.
“Inflation is expected to rise again later this year, partly because the sharp declines in energy prices will fall out of the annual calculations. Inflation should then ease toward our target in the second half of next year,” the ECB stated.
However, the central bank slightly revised its core inflation outlook upward due to stronger-than-anticipated services inflation. Excluding energy and food, staff now expect inflation to average 2.9% in 2023, compared to a previous estimate of 2.8%, before cooling to 2.3% in 2025, up from June’s forecast of 2.2%. Core inflation remains projected to reach 2.0% by 2026.
Economic growth forecasts were adjusted slightly downward, with the ECB now expecting growth of 0.8% in 2024, 1.3% in 2025, and 1.5% in 2026—each 0.1 percentage points lower than June’s estimates.
Eurozone inflation edged up slightly in July. While this represents a modest increase, it signals that inflationary pressures persist in the region.
Market analysts and economic models anticipate inflation cooling in the coming months. Trading Economics forecasts a rate of 2.2% by the end of the quarter. This projected decline is likely influenced by factors such as easing supply chain disruptions and a potential moderation in energy prices.
Looking further ahead, long-term projections suggest the Eurozone inflation rate will stabilize around 2.1% in 2025. This figure aligns with the European Central Bank’s inflation target of close to, but below, 2%.
However, the realization of this projection hinges on various economic conditions, including global economic growth, geopolitical developments, and the effectiveness of monetary policy measures.
The European Central Bank (ECB) serves as a central component within the Eurosystem and the European System of Central Banks (ESCB), making it one of the seven institutions of the European Union (EU). It holds a position of immense significance on the global stage as one of the world’s foremost central banks.
The ECB Governing Council is responsible for formulating monetary policy for both the Eurozone and the European Union. It manages the foreign exchange reserves of EU member states, conducts foreign exchange operations, and defines the intermediate monetary objectives and key interest rates within the EU.
To execute these policies and decisions, the ECB Executive Board operates under the authority of the Governing Council and may issue directives to the national central banks as needed. Additionally, the ECB possesses the exclusive authority to authorize the issuance of euro banknotes. Meanwhile, the issuance of euro coins by member states requires prior approval from the ECB. The ECB also oversees the functioning of the TARGET2 payments system.
Established in May 1999 through the Treaty of Amsterdam, the ECB’s crucial mission is to ensure and preserve price stability. Subsequently, on Dec. 1, 2009, the Treaty of Lisbon came into effect, officially designating the ECB as an EU institution.
Initially, the ECB was established to serve the Eurozone, consisting of eleven member countries. Over time, the Eurozone expanded to include Greece in Jan. 2001. It also added Slovenia in Jan. 2007, Cyprus, and Malta in Jan. 2008. Furthermore, Slovakia in Jan. 2009, Estonia in Jan. 2011, Latvia in Jan. 2014, Lithuania in Jan. 2015, and Croatia in Jan. 2023.
Currently, President Christine Lagarde leads the ECB, which has its headquarters in Frankfurt, Germany. Before its new headquarters, it operated from the Eurotower.
The ECB operates in direct accordance with European Union law. Its €11 billion capital stock is collectively owned by all 27 central banks of EU member states as shareholders. Based on the population and GDP of member states, the initial capital allocation key was established in 1998 but has since undergone adjustments. Notably, shares within the ECB are non-transferable and cannot serve as collateral.
The key interest rates are instrumental tools the ECB uses within its operational framework to preserve price stability within the euro area.
These rates hold significant importance in conducting monetary policy, as they directly impact the cost of borrowing for various economic entities. These include governments, businesses, and households, both in capital markets and the market for bank loans. Furthermore, they influence the returns on various saving instruments, such as bank deposits.
Consequently, the ECB’s monetary policy decisions have a far-reaching impact on households and businesses spending, saving, and investment choices. It ultimately affects overall economic activity and, in turn, inflation rates.
The ECB maintains three key interest rates:
ECB establishes this rate to provide the banking system with weekly liquidity injections. It determines the cost credit institutions incur when borrowing funds from the ECB for one week.
The ECB also sets the rate for the deposit facility. This dictates the interest paid to credit institutions for overnight deposits held at the central bank. Notably, the deposit facility rate remained negative from 2014 until July 2022.
This rate represents the cost credit institutions bear when they borrow money overnight from the ECB.
These interest rates are pivotal in the ECB’s pursuit of its monetary policy objectives. They significantly influence the broader economic landscape and inflation dynamics.
Given the many current uncertainties, formulating a realistic forecast for ECB interest rates over the next five years presents a considerable challenge. Nevertheless, the European Central Bank itself has offered projections extending as far as 2025 in its survey of professional forecasters.
Trading Economics anticipated a decrease to 2.75% in 2024 and a further decline to 1.5% in 2025, based on their econometric models.
Cryptocurrencies, Bitcoin included, have demonstrated remarkable resilience even in the face of rising interest rates. Notably, Bitcoin experienced significant growth, with a surge of 2,000% observed between 2015 and 2016.
However, it is crucial to recognize that elevated interest rates can produce diverse effects on the cryptocurrency market. Some experts argue that persistently high inflation, rising gas prices, and increased energy costs linked to higher interest rates may potentially reduce risk appetite, thus creating challenges for cryptocurrencies.
Central banks wield significant influence in shaping economic conditions, directly impacting money circulation and financial market stability. Their ability to adjust interest rates directly affects borrowing rates for financial and banking institutions.
In response to widespread inflation, major central banks in developed economies, such as the Fed, the ECB, and the BoE, have chosen to raise interest rates.
It is worth noting the increasingly intertwined relationship between cryptocurrencies and these macroeconomic and monetary shifts. The decisions to raise interest rates, particularly by the Fed, have immediate repercussions for cryptocurrency markets.
The Federal Reserve’s more assertive stance has injected uncertainty into the cryptocurrency space, which has also affected market sentiment as tighter monetary policies take hold.