Overview
Were you surprised to see eurozone interest rates cut before those in the US, Salman?
I was not. In fact, it has been our view for a while now. When markets were pricing last year for the US Federal Reserve to cut rates earlier than the European Central Bank (ECB), we said it was not consistent with the underlying dynamics or the data.
So can we expect more cuts?
We believe there will be two cuts this year, which is basically consistent with the tone both of the ECB’s June statement and the press conference. Both were cautious and kept the ECB’s options open. The elephant in the room is the Fed, whose policy will have a big bearing on how much Frankfurt can cut in the months ahead. July seems clearly off the table for a quick follow-up rate cut, but ECB President Lagarde has kept the door wide open for the remainder of the year.
Any additional reduction in interest rates will depend on more disinflation. The speed and timing of further cuts will be determined by a broad set of data including profit margins, labour costs and wages that are only available each quarter.
Why has the ECB gone first?
The economic fundamentals in Europe are different from the US. The eurozone economy has responded much more strongly to the rate hiking cycle. The transmission channel for policy is much faster in Europe because of the structure of debt markets and of mortgages, which are obviously an important way by which higher rates are transmitted to the real economy.
By contrast, the US economy has been in much stronger shape. The labour market is much tighter and, of course, inflation has been stickier.
But you are less worried about the eurozone economy than you were last year?
There were interesting developments this month: the ECB also revised its inflation forecast higher for the next two years and, even for 2026, the projection is now around 2 per cent. Growth was also revised higher, which does invite the question of why they’re cutting now.
I think the risks that we saw last year are rebalancing. European growth is picking up. Growth in the US is slowing down and I think that will be the direction of travel for the next six months. The flow of recent European data is consistent with a rebound; the impact of the generally higher level of rates is being absorbed; wages are strong. You have the manufacturing sector rebounding after being under pressure and supply side issues continue to be resolved.
The recovery is also becoming more broad-based with the industrial sector continuing to bottom out. However, we agree with the ECB that risks to the growth outlook remain skewed to the downside. The transmission mechanism remains more effective in the eurozone and credit activity is yet to pick up meaningfully with current levels of restrictiveness. Meanwhile, recent data on wages and inflation have surprised to the upside and remain elevated. While the ECB’s wage tracker shows wage growth is expected to moderate over the course of the year, we expect the council members will be more cautious after this cut and take rate decisions meeting by meeting.
Given US inflation remains sticky, we still don’t expect any cuts by the Fed this year, which is likely to restrain the ECB from diverging too much to avoid a weaker euro and risk renewed inflationary pressures.
Will that restraint protect the euro from more depreciation?
I think the risk to the currency relates to the Fed’s moves and how much the ECB can calibrate its own policy, keeping those risks in mind. We are expecting range-bound action from here in foreign exchange markets for the moment, because on balance the two central banks are quite closely aligned in terms of how they view things.
How worried should investors be about growth in Europe dropping off again?
It's not a key concern for us right now. Rates have been higher for a longer period now and the ECB needs to be very careful that it does not damage growth down the line. But the kind of extreme risks that we saw last year are probably dissipating.
