The European Central Bank (ECB) is poised to make a significant shift in its monetary policy as key policymakers signal their readiness to cut interest rates at the upcoming June 6 meeting.

With inflation in the euro area falling close to the central bank’s 2% target, the ECB is set to become one of the first major central banks to ease borrowing costs, marking a departure from its previous stance.

TLDR

• The European Central Bank (ECB) is expected to cut interest rates at its June 6 meeting, with policymakers indicating it is practically a done deal.
• Inflation in the euro area has fallen close to the ECB’s 2% target, prompting the central bank to consider easing monetary policy.
• The ECB is likely to move sooner than the U.S. Federal Reserve in cutting rates, decoupling from the Fed’s monetary policy decisions.
• Policymakers debate the timing and pace of subsequent rate cuts, with some advocating for a gradual approach while others caution against committing to a specific timeline.
• The ECB aims to keep rates in restrictive territory throughout the year to ensure inflation continues to ease and does not get stuck above the 2% target.

ECB chief economist Philip Lane and governing council member Olli Rehn have both indicated that the time is ripe for the central bank to start cutting rates, barring any major surprises.

This move comes as inflation in the euro area held steady at 2.4% in April, marking the seventh consecutive month below 3%. The expected rate cut is seen as a necessary step to ensure that the disinflationary trend continues and inflation converges to the ECB’s target in a sustained manner.

The ECB’s decision to cut rates is likely to decouple it from the monetary policy of the U.S. Federal Reserve, which usually leads the way in such decisions.

While the Fed is expected to maintain its current stance for the time being, the ECB is prepared to take action sooner.

This divergence in monetary policy has sparked discussions among analysts and market participants about the potential implications for the euro and the broader financial landscape.

As the debate shifts to the timing and pace of subsequent rate cuts, ECB policymakers are adopting a cautious approach.

While some, like French central bank chief Francois Villeroy de Galhau, advocate for maintaining flexibility and assessing the situation on a meeting-by-meeting basis, others, such as board member Isabel Schnabel, have already begun discussing the possibility of a pause after the initial rate cut.

Philip Lane, in his role as chief economist, emphasizes the need for the ECB to keep rates in restrictive territory throughout the year to ensure that inflation continues to ease and does not become entrenched above the 2% target.

He warns that keeping rates overly restrictive for too long could push inflation below the target over the medium term, requiring corrective action through an acceleration in rate cuts.

The ECB’s decision to cut rates is not without its challenges. Some analysts have raised concerns that if the central bank diverges from the Fed by cutting rates more aggressively, it could lead to a depreciation of the euro and potentially push up inflation by increasing the price of imports.

However, Lane dismisses these fears, pointing out that there has been little movement in the exchange rate and that delays in the expected timing of Fed rate cuts have actually pushed up U.S. bond yields, which in turn has lifted long-term yields of European bonds.

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