Christine Lagarde has warned that the European Central Bank’s fight against inflation is far from over even after policymakers announced the first interest rate cut in five years.
In a major turning point, the ECB’s president said all but one of its officials had backed a cut in all three of its key interest rates, reducing its benchmark deposit rate to 3.75pc from 4pc in the first cut since 2019.
However, Ms Lagarde signalled the central bank was not “moving into a dialing-back phase”, suggesting future rate cuts would depend on the strength of the jobs market and pay.
Even so, the move suggests borrowing costs in Europe are likely to diverge further from the US Federal Reserve, where a strong jobs market has forced traders to abandon hopes of more than one US interest rate cut this year.
It will also pile more pressure on the Bank of England to start cutting rates this summer.
The Monetary Policy Committee (MPC) raised interest rates to a 16-year high of 5.25pc last August, and has held them there ever since.
While the highly-anticipated move has already helped to boost Europe’s flagging housing market, economists warned the ECB not to “declare victory on inflation”.
Sporting a gold necklace emblazoned with the words “in charge”, Ms Lagarde agreed that the fight was not over as she stressed that decisions on future rate cuts would be taken “meeting by meeting”.
“Let there be no doubt about our determination to tame inflation and restore price stability,” she told reporters on Wednesday.
“There is one thing I have learned in this job and that is we have to be persistent, we have to be determined, we have to be data dependent, but we cannot give up on the objective.
“And our objective is to tame inflation and to bring it back to 2pc in the medium term.”
While Ms Lagarde admitted that the task of taming inflation had led to “sleepless nights”, she said there was also a risk that inflation could fall much faster. Noting that inflation had halved each year over the past two years to 2.6pc today, Ms Lagarde added: “I don’t want to divide inflation again by two. We don’t want to go there.”
Analysts said pay pressures across the bloc were likely to keep inflation higher for longer, limiting the number of rate cuts this year. Ms Lagarde said policymakers were watching pay closely.
“Wages matter enormously,” she said.
It also comes against a backdrop of falling borrowing costs around the world, with the Swiss becoming the first major Western economy to cut interest rates in March, lowering its main policy rate by 0.25 percentage points to 1.5pc.
In May, Sweden’s central bank followed suit, while the Bank of Canada lowered rates to 4.75pc on Wednesday, becoming the first G7 central bank to do so.
The ECB said the decision to reduce borrowing costs reflected a “marked” easing of price pressures in the economy, with inflation currently at 2.6pc, down from a peak of 10.6pc at the end of 2022.
However, acknowledging that high inflation has not been vanquished, policymakers conceded that “domestic price pressures remain strong”, with inflation “likely to stay above target well into next year”.
The ECB now believes inflation will average 2.5pc this year, up from 2.3pc in its last forecast in March.
Price rises are expected to average 2.2pc in 2025, up from a prediction of 2pc previously. This suggests inflation will not fall back to its 2pc target for more than a year.
Core inflation, which strips out volatile movements in food and energy, is also predicted to remain higher for longer, while growth is forecast to pick up to 0.9pc this year, from a previous prediction of 0.6pc.
Policymakers said high interest rates were still bearing down on growth as they vowed to keep them high “for as long as necessary to achieve this aim”.
In a sign that the ECB’s move does not represent the start of a string of rate cuts, the central bank said it would “follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction”.
“Despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year,” it said in a statement.
Yael Selfin, chief economist at KPMG, said the ECB was right to take a cautious approach.
She said: “The eurozone economy is in a different place than the US, which is subject to a resurgence in inflation and a looser fiscal stance.
“Nonetheless, the European labour market remains relatively tight, with unemployment at its lowest level since the euro was introduced and pay growth remaining elevated.”
ECB data show annual pay growth among workers who collectively negotiate pay increased by 4.5pc in the final quarter of 2023, compared with 4.7pc in the previous quarter.
Ms Selfin added: “ECB officials have stressed that the rate cut should not be interpreted as a declaration of victory on inflation.”
There are signs that UK policymakers are also becoming more concerned about the need to support growth.
But hopes of a move this month were dashed by inflation data that showed the economy is cooling less quickly than expected, with inflation dropping to 2.3pc in April, slightly higher than the Bank’s own forecast of 2.1pc.
Rishi Sunak’s hopes for a pre-election boost from the Bank are also likely to be dashed. It has not cut rates in the weeks before an election since becoming independent in 1997.
There remain big divisions among Threadneedle Street’s nine rate setters, with two policymakers already calling for cuts and Governor Andrew Bailey saying reductions are “on the way”, but others suggesting any cut is still some distance off.
The key factor for the Bank is wages. Pay growth remains stubbornly strong, even though unemployment is at its highest for almost a year at 4.3pc, according to the Office for National Statistics (ONS).
Pay rises currently average 6pc, which the Bank has repeatedly said is not consistent with its 2pc target.
Data capturing April’s pay deals, when around 40pc of people get a pay rise will also be closely watched by the Bank. April also saw a big jump in the national minimum wage.
Separate data on Thursday suggested things are moving in the right direction, with price pressures easing across the British economy.
Finance chiefs polled by the Bank expect wage growth to fall and the cost of borrowing to decline over the next year in a boost for rate cut hopes.
Bosses now believe UK wage growth will average roughly 4.5pc over the next year, which is down 0.3 percentage points from their April outlook.
Average corporate borrowing costs are also falling, helping to ease pressure on finances. Firms expect to increase prices by 3.9pc over the next year, which was down slightly from 4pc in April and the lowest since September 2021.
Europe’s housing market has been battered by higher interest rates, which have climbed dramatically since July 2022.
EU house prices fell for the first time in a decade last year, led by steep declines in Germany, which has seen a 14pc drop since they peaked in 2022. This has led to a slump in demand which is only just starting to pick up.
Joe Nellis, of the Cranfield School of Management, said that while the ECB’s move signalled that a rate-cutting cycle was well underway, policymakers on both sides of the Atlantic were likely to remain cautious.
He said: “With Canada cutting rates on Wednesday there will be growing expectations that the UK and US will follow suit shortly. The big question is when.
“However, the Bank of England along with the ECB will need to ensure that they do not fire the starting gun too fast and trigger another spike in inflation.”
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