The European Central Bank sent a clear signal that it will cut interest rates from their record highs next week, as its chief economist shrugged off concerns that doing so ahead of the US Federal Reserve would backfire.
The European Central Bank now seems almost certain to be among the first major central banks to cut interest rates, having been criticised for being one of the last to raise them after the biggest bout of inflation in a generation (about 33 years) three years ago.
Philip Lane told the Financial Times in an interview conducted ahead of the bank's historic meeting on June 6, which was viewed by Sky News Arabia: Barring major surprises, at this time there are enough indicators to remove the highest level of interest rates.
Investors are betting heavily that the European Central Bank will cut its key deposit rate by a quarter percentage point from its record high of 4 percent at a meeting next week after euro zone inflation edged closer to the bank's 2 percent target.
Central banks in Switzerland, Sweden, the Czech Republic and Hungary have cut borrowing costs this year in response to falling inflation. But among the world’s biggest economies, the Federal Reserve and the Bank of England are not expected to cut rates before the summer and the Bank of Japan is likely to keep raising them.
Asked if he was proud that the ECB was in a position to cut interest rates earlier than others, Lane said: “Central bankers strive to be as boring as possible, and I hope central bankers strive to have as little ego as possible.”
He added that one of the main reasons why inflation in the eurozone has fallen faster than in the United States is that the region has been more affected by the shock caused by the Russian war on Ukraine in the energy sector. He said that dealing with the war and the energy problem has been costly for Europe, explaining: But in terms of that first step (in starting to cut interest rates), it is a sign that monetary policy has been working in making sure that inflation comes down in time. In that sense, I think we have succeeded.
ECB policymakers need to keep interest rates in a restrictive zone this year to ensure inflation stays low and does not overshoot the bank's target, which he warned would be too big a problem and probably too painful to eliminate, Lane said.
However, he said the pace at which the central bank cuts borrowing costs in the euro zone this year will be determined by assessing the data to decide whether it is proportionate, whether it is safe, within the constrained area, to move down.
Continued restriction with room to move
It will be volatile and it will be gradual, said Lane, who is responsible for drafting and presenting the proposed interest rate decision before it is taken by the bank's 26-member board next week.
The best way to frame the discussion this year is that we still need to be tight throughout the year, he added, but within the tightening zone, we can move somewhat lower.
Despite recent data showing eurozone wage growth accelerating to a near record pace at the start of this year, Lane said: “The overall wage trend still points to a slowdown, which is essential,” adding that this is supported by the European Central Bank’s wage tracking initiative.
Some economists have warned that if the ECB deviates from the Fed by cutting interest rates more aggressively, it could depreciate the euro and raise inflation by making imports into the euro zone more expensive.
Lane said the ECB would take any significant movement in the exchange rate into account, but noted there had been very little movement in that direction. The euro has recovered a fifth against the U.S. dollar from a six-month low in April and remains high over the past year.
Instead, he said, delays in the expected timing of a rate cut by the Federal Reserve had sent U.S. Treasury yields higher, which had lifted longer-term yields on eurobonds.
This mechanism means that for any interest rate we set, you get an additional tightening from US conditions, he said, noting that the ECB may have to compensate for this with additional cuts to the short-term deposit rate.
All other things being equal, if the long-term tightening is severe, how do you think about short-term changes?
Inflation battle still requires tight monetary policy
Although eurozone inflation has fallen from its peak of above 10% in 2022 to a near three-year low of 2.4% in April, it is expected to rise slightly to 2.5% when May data is released this week.
The European Central Bank's chief economist Philip Lane has warned that a significant amount of cost pressure from rapid wage growth is pushing up service prices, meaning the ECB will have to keep monetary policy tight until 2025.
He said: Next year, as inflation clearly approaches the target, then making sure that interest rates come down to a level consistent with that target - there will be different statements and different discussions.
The ECB's overall rate cuts will depend on its assessment of the so-called neutral rate, the point at which savings and investment balance at the desired levels, output is at economic potential and inflation is at target.
Estimates of the neutral rate vary, but Lin said it would likely result in an interest rate at or just above 2 percent, though it could be higher if a strong green shift to renewable energy or massive gains from generative AI lead to a surge in investment.
