Why the European Central Bank is cutting interest rates now

Sabri Ben-Achour Jun 6, 2024
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Christine Lagarde, president of the European Central Bank. Energy prices, lifted by supply shortages caused by Russia's war in Ukraine, played a big role in inflation on the Continent. Kirill Kudryavtsev/AFP via Getty Images

Why the European Central Bank is cutting interest rates now

Sabri Ben-Achour Jun 6, 2024
Heard on:
Christine Lagarde, president of the European Central Bank. Energy prices, lifted by supply shortages caused by Russia's war in Ukraine, played a big role in inflation on the Continent. Kirill Kudryavtsev/AFP via Getty Images
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The European Central Bank has decided its fight against inflation is wrapping up — it cut interest rates Thursday for the first time since 2019. It’s ahead of the Federal Reserve here in the U.S., which hasn’t cut rates and isn’t expected to for several months, if at all this year. That’s despite the fact that inflation was more severe across the pond than in the U.S. and the ECB was later to the game in fighting it than the Fed. So what gives?

Two years ago to the month, U.S. inflation peaked at around 9%. In Europe, it would get worse — nearly 11%. But European inflation was different.

“In Europe, it was very much driven by the energy price shock following Russia’s invasion in Ukraine,” said Nick Rees, a foreign exchange analyst at Monex, based in London. In some countries the Ukraine war raised the cost of electricity by 70% or more. But as Europe found new supplies, prices came back down. In the U.S., higher prices turned into higher wages, which turned into higher prices, which turned into higher wages. But in Europe, not as much.

“In Europe, labor markets are a bit more rigid. Those pay adjustments happen a bit slower,” Rees said.

Europe’s economy also didn’t enjoy a government massive stimulus like the U.S. did, so it didn’t similarly overheat. In fact, high energy prices dragged Europe’s economy down, kind of like how interest rate hikes do.

“The European economy has barely grown since mid-2022,” said Diego Iscaro, head of the European economic team at S&P Global in London.

“If you look at the underperformance of Europe, it actually comes even earlier than the start of the war in Ukraine,” he said.

But just as growth and inflation worked a little differently in Europe, so did Europe’s central bank. “Monetary policy transmits harder in Europe because there’s a lot more interest-sensitive debt,” said Van Hesser, chief strategist at KBRA.

From mortgages to loans, European debt is more sensitive to central bank decisions. For all of these reasons, the ECB didn’t want or need to push as hard to fight inflation, and it’s letting up on the brakes a little faster than the Fed.

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