The European Central Bank might beat the Fed to interest rate cuts
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Wednesday's elevated U.S. inflation reading made interest rate cuts from the Federal Reserve look more distant. The Fed's counterparts across the Atlantic were unfazed.
Why it matters: The European Central Bank now looks poised to kick off the global interest rate-cutting cycle among major economies. It strongly hinted Thursday that this could happen in June — which would likely front-run the Fed in a huge policy pivot.
Driving the news: The ECB added an intriguing sentence to its policy statement that all but confirms it's on track to cut rates soon.
- If incoming data gives the ECB "confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction," the statement reads.
What they're saying: That rate cut move could come regardless of inflation and monetary policy developments in the U.S.
- "I have said we are data dependent, we are not Fed dependent," ECB president Christine Lagarde told reporters Thursday morning, later adding that the ECB does not take its "cue" from the U.S. Consumer Price Index.
- "We have to focus on what we have jurisdiction for, which is the euro area — taking into account what happens in the rest of the world, but not assuming that what happens in the euro area will be the mirror of what happens in the United States," Lagarde said.
- Lagarde conceded that a few policymakers already "felt sufficiently confident" and were ready to cut rates.
Between the lines: It amounts to the ECB's "declaration of independence" from the Fed, write Evercore ISI analysts Krishna Guha and Marco Casiraghi.
- While global central bankers are charged with setting policy based on their domestic economic conditions, the existence of global spillovers — through currency fluctuations, financial market moves and more — makes them wary of acting too far out of step with their global counterparts.
- That has been particularly true between the Fed and ECB, the two most important world central banks, which closely communicate their intentions in hopes of avoiding unnecessary disruption to trade and financial flows.
Recent U.S. inflation data has come in strong alongside signs of solid economic activity. Meanwhile, inflation in the euro area has continued to ease, coming down from its peak of nearly 11% in late 2022 to 2.4%, as of March, amping up bets that a rate cut is on the horizon.
- The ECB has diverged from the Fed in the past — like in 2011, when it cut rates as it faced a sovereign debt crisis — though it's rare.
- Too big of an interest rate differential could put pressure on the euro — though Lagarde said the central bank doesn't target currency exchange rates.
What to watch: Europe's steep inflation drop is largely explained by the nature of the shock. There, soaring prices were primarily the result of a massive jump in energy costs caused by Russia's invasion of Ukraine, which led to a cutoff in energy supply.
- That's a contrast to the U.S., which saw inflation surge mainly because of a tight labor market and strong consumption.
The bottom line: Lagarde said that what happens in the U.S. will find its way into the ECB's economic outlook. But since the inflation shocks were different, it might be the case that how they end will look different, too.
- "I don't think we can draw conclusions based on an assumption that the two 'inflations' are the same," Lagarde added. "The two economies are not the same — the political regimes are not the same, the fiscal policies are different."
