Europe cuts interest rates, following Canada

While the Federal Reserve is not yet ready to start cutting interest rates in the United States, other major economies around the world have made enough progress in fighting inflation to start lowering borrowing costs.

The European Central Bank (ECB) said on Thursday it would cut each of its three key interest rates by 0.25 percentage points, lowering its key deposit rate to 3.75 percent from next week.

The rate has been held at a record 4% since September last year as part of the quantitative tightening program implemented by most developed countries in the aftermath of their response to the pandemic.

“Inflation has fallen by more than 2.5 percentage points. [since September] “The inflation outlook has improved significantly. Underlying inflation has also moderated, price pressures have eased and there are growing signs that inflation expectations have fallen across all horizons,” the ECB’s Governing Council said in a statement on Thursday.

The move comes after the Bank of Canada cut its benchmark interest rate from 5% to 4.75% on Wednesday, making it the first G7 country to cut its key policy rate.

“If the economy continues to develop broadly as expected and inflationary pressures continue to ease, it is reasonable to expect further interest rate cuts,” Bank of Canada Governor Tiff Macklem said Wednesday.

Eurozone inflation was forecast at 2.6% in May, down from 5.4% in 2023. In its latest economic forecasts, the ECB raised its inflation forecast for this year to 2.5% from 2.3%. It now sees inflation falling to 2.2% in 2025 and 1.9% in 2026.

U.S. inflation has been stronger than expected, with the Consumer Price Index (CPI) running above 3% for nearly a year. The Fed’s preferred inflation measure, the Personal Consumption Expenditures (PCE) price index, fell to 2.7% in April.

The Federal Reserve is not expected to cut interest rates at either of its next two meetings, and there is debate about whether it plans to cut rates this year.

Market commentators noted on Thursday that central banks are under pressure to remain broadly coordinated.

“Given the increasing likelihood that the Fed will not cut rates this year and the ECB has revised its 2025 inflation forecast to 2.2%, above its target, we expect the ECB to cut rates just one more time this year,” said Morgan Delledon, head of European investment strategy at ETF firm Global X.

“We expect the ECB to try to avoid a widening of the spread between the two regions, which could otherwise lead to a sell-off of the euro against the US dollar,” she said.