ECB Slashes Rates by 25bps; Forecasts Increased Stagflation

The European Central Bank (ECB) has reduced its rates by 25 basis points to 3.50% as anticipated. The central bank confirmed in its statement that it would continue to follow a data-dependent path, reduce its Pandemic Emergency Purchase Programme (PEPP) by €7.5 billion a month, and increase inflation expectations while reducing growth expectations.

Inflation Expectations on the Rise

The ECB staff has raised its inflation expectations. For 2024, the ECB predicts inflation excluding food and energy to be at 2.9%, up from 2.8%. For 2025, the inflation rate is expected to be 2.3%, up from 2.2%. For 2026, the inflation rate is projected to remain at 2%. The overall inflation for 2026 is predicted to be 1.9%, the same as the previous forecast.

Downward Revision of Growth Expectations

The central bank has also revised its growth expectations. The staff projects that the economy will grow by 0.8% in 2024, 1.3% in 2025, and 1.5% in 2026. This is a slight downward revision compared to the June projections, primarily due to a weaker contribution from domestic demand over the next few quarters.

Forward Guidance Remains Unchanged

Despite these changes, the ECB's forward guidance remains unchanged. The Governing Council is committed to ensuring that inflation returns to its 2% medium-term target promptly. The council will maintain policy rates as restrictive as necessary for as long as it takes to achieve this goal. The council will continue to follow a data-dependent and meeting-by-meeting approach, without committing to a specific rate path. The euro remained largely unchanged following the statement.

Full ECB Statement

In its full statement, the ECB announced its decision to lower the deposit facility rate by 25 basis points. Based on the Governing Council's updated assessment of the inflation outlook, the dynamics of underlying inflation, and the strength of monetary policy transmission, it is now appropriate to take another step in moderating the degree of monetary policy restriction. The staff sees headline inflation averaging 2.5% in 2024, 2.2% in 2025, and 1.9% in 2026, as in the June projections. Inflation is expected to rise again in the latter part of this year, partly because previous sharp falls in energy prices will drop out of the annual rates. Inflation should then decline towards the ECB's target over the second half of next year.

Domestic Inflation and Economic Growth

Domestic inflation remains high as wages are still rising at an elevated pace. However, labour cost pressures are moderating, and profits are partially buffering the impact of higher wages on inflation. Financing conditions remain restrictive, and economic activity is still subdued, reflecting weak private consumption and investment.

Key ECB Interest Rates

The Governing Council decided to lower the deposit facility rate by 25 basis points. The deposit facility rate is the rate through which the Governing Council steers the monetary policy stance. Accordingly, the deposit facility rate will be decreased to 3.50%. The interest rates on the main refinancing operations and the marginal lending facility will be decreased to 3.65% and 3.90% respectively. The changes will take effect from 18 September 2024.

Asset Purchase Programme (APP) and Pandemic Emergency Purchase Programme (PEPP)

The APP portfolio is declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities. The Eurosystem no longer reinvests all of the principal payments from maturing securities purchased under the PEPP, reducing the PEPP portfolio by €7.5 billion per month on average. The Governing Council intends to discontinue reinvestments under the PEPP at the end of 2024.

Bottom Line

The ECB's decision to cut rates and its revised inflation and growth expectations reflect the ongoing economic challenges Europe faces. The central bank's commitment to ensuring inflation returns to its 2% medium-term target in a timely manner, despite the economic uncertainties, is noteworthy. What are your thoughts on the ECB's decisions and projections? Do you think these measures will help stabilize the economy? Please share this article with your friends and join the conversation. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6 pm.