European Central Bank cuts benchmark rate by a quarter point as inflation falls

The European Central Bank cut its key interest rate Thursday by a quarter-point to 3.5% as inflation subsided and the bank sought to boost economic growth with lower borrowing costs for companies and consumers

The European Central Bank has taken a step towards supporting growth by cutting interest rates yet again on Thursday amid easing inflation, offering lower borrowing costs for businesses and those looking to own property.

It's anticipated that the US Federal Reserve will also be cutting interest rates in the near future. At its towering headquarters in Frankfurt, the bank's decision-makers cut the deposit rate from 3.75% down to 3.5%. This marked the ECBs second downward adjustment as it begins easing off the aggressive rate hikes previously implemented to extinguish soaring double-digit inflation triggered after Russia reduced its natural gas exports due to its conflict with Ukraine.

However, economic forecasters are not expecting the European Central Bank or the American Fed to embark on a swift descent to the ultra-low rates seen prior to the pandemic outbreak in 2020. Forecasts suggest the ECB will proceed with caution perhaps trimming rates only once more this year.

Oil price reductions have contributed to scaling back inflation. Inflation in the Eurozone comprising 20 nations fell to 2.2% come August, edging close to the ECB's ideal of 2%, down sharply from a high of 10.6% reported in October 2022. During her press briefing after the decision, ECB President Christine Lagarde acknowledged recent indicators reaffirmed "our confidence that we are heading towards our target in a timely manner."

Concerning the upcoming meeting set for October 17, she said: "I'm not giving you any commitment of any kind as far as that date is concerned."

However, she refrained from providing any guidance on potential future rate cuts. Instead, she emphasized that the bank would make decisions on a meeting-by-meeting basis, taking into account the latest economic data, and was "not pre-committing to a particular rate path."

Policymakers must remain vigilant about inflationary pressures in the services sector and rising wages, as workers seek to regain purchasing power lost due to the post-pandemic inflation surge. The ECB implemented a rate cut in June, followed by a pause in July, before taking a summer break in August.

The rate-setting council, led by President Christine Lagarde, must balance concerns about disappointing growth prospects, which argue for rate cuts, against the need to ensure inflation reaches and remains at the bank's 2% target, which would support maintaining higher rates for a longer period.

Consumer prices skyrocketed after Russia's February 2022 invasion of Ukraine led to a significant reduction in natural gas shipments to Europe, causing utility bills to rise. The post-pandemic rebound also resulted in supply chain bottlenecks, further fueling inflation that eventually spread to the services sector, including medical care, personal services, restaurants, hotels, and entertainment.

In response, the ECB and the Fed implemented rapid rate hikes, with the ECB raising its benchmark rate to a record high of 4% before cutting it to 3.75% in June. The central bank's benchmark rate has a significant influence on the borrowing costs of private-sector banks, which in turn affects rates across the economy.

Higher rates can curb inflation by making borrowing and purchasing more expensive, thus restraining price increases. However, high rates can also hinder growth, a concern that is becoming increasingly prominent.

In Europe and the US , higher rates have led to increased mortgage costs for home buyers and higher payments for those with credit card debt or car loans. On the flip side, they have benefited savers and retirees who appreciate interest income and are now seeing tangible returns on their bank holdings or money market accounts after years of zero returns.

The Fed is anticipated to make its first cut in its benchmark rate at its meeting on Sept. 17-18 from a 23-year high of 5:25%-5.5%. Consumer prices rose 2.5% in August from a year earlier, down from 2.9% in July, marking the fifth consecutive annual drop in inflation. Core inflation, which excludes volatile fuel and food prices and can be a more reliable indicator, was higher at 3.2%.

Brian Coulton, chief economist at Fitch Ratings, said: "The long-awaited Fed easing cycle is upon us," but he added that the Fed rate-setters "will be cautious after the inflation challenges of the past few years. The pace of rate cuts will be gentle and monetary easing won't do much to boost growth next year."

Europe's growth has been lacklustre, with a mere 0.3% increase in the second quarter of this year and an approximate 1.0% annual rate based on the performance in the first half. This comes after over a year of near-zero stagnation.

Recent indicators of business and consumer sentiment, coupled with a barrage of negative news from the eurozone's largest economy, Germany, have quashed hopes for a stronger recovery.

Germany's economy shrank by 0.1% in the second quarter, and its future looks bleak amidst a global manufacturing slowdown. Adding to these woes are long-term issues such as an ageing population, a shortage of skilled workers, delayed implementation of digital technology, and excessive bureaucracy that hampers business creation and growth.

Major employer Volkswagen has reneged on its no-layoffs pledge, which was supposed to last until 2029, as it looks to reduce costs. The company has also warned that it may need to shut down one or more factories in Germany due to decreased demand for its new electric vehicles in Europe and China.