Meeting expectations

At its 6 June monetary policy meeting, the ECB cut its main refinancing rate, marginal lending facility and deposit facility rates by 25bps to 4.25%, 4.50% and 3.75% respectively. The decision was widely anticipated following clear guidance by President Lagarde and other ECB board members in recent speeches and reduces European interest rates from their 23-year high.

In the accompanying statement, the board justified its decision to “moderate the degree of monetary policy restriction” based “on an updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission”. However, the central bank also reaffirmed its commitment to returning inflation to its 2% medium-term target by keeping “policy rates sufficiently restrictive for as long as necessary to achieve this aim”.

At the subsequent press conference, President Lagarde confirmed the ECB cut was due to “confidence in the path ahead”, but was very reticent to provide additional forward guidance, stating that the central bank “would need more data to confirm that we are on a disinflationary path” before taking further actions.

Better data, restrictive rates

The Governing Council noted that “the inflation outlook had improved markedly” with headline and core inflation has declining sharply from a peak of 10.6% year on year in the middle of 2022 to 2.6% in May 2024. However, the pace of declines has moderated over the past several months with headline and core inflation edging higher as services prices proved more persistent than expected. The ECB’s latest staff projections forecast that “inflation is likely to stay above target well into next year” with headline inflation projections higher at 2.5% in 2024, 2.2% in 2025 and only dropping below 2% in 2026.

Concurrently, the eurozone economy is showing signs of gradual improvement with first quarter GDP slightly better than expected at 0.3% quarter on quarter, helped by robust household spending. Weak manufacturing is offset by a resilient services sector – reflected in improved consumer confidence and higher retail sales – aided by robust employment and higher wage growth. This allowed the ECB to raise its growth forecasts to 0.9% year on year in 2024 while maintaining 1.6% in 2026.

Market reaction and fund positioning

Ahead of the meeting, the market had fully priced a rate cut, with an additional 1.6 cuts priced in for the remainder of 2024. Following the announcement, however, bond yields moved higher as the market reduced the probability of future cuts.

J.P. Morgan Asset Management’s liquidity and ultra-short duration strategies are well positioned to take advantage of the rate cut, having extended duration via purchases of longer maturity fixed securities to lock in longer tenor yields. Strategy yields will decline as time deposit rates reset lower, but the subsequent pace of decline will be slower.

Conclusion

The ECB's recent decisions reflect a delicate balance between controlling inflation and supporting economic growth. Given the widespread signalling that a rate cut was likely, it would have damaged the ECB’s credibility had it not acted. Although, subsequent ECB comments were hawkish, cautioning that it is “not pre-committing to a particular rate path”, and indicating that the pace and size of future rate cuts remains uncertain and data dependent.

However, with inflation moderating, we think the rate cut was logical to ensure rates do not become overly restrictive rather than a sign of outright monetary policy easing. We also believe that regardless of the ECB’s hawkish rhetoric, the rate cut reflects an inflection point and the future path for EUR interest rates is lower.

For EUR cash investors, the rate cut will likely trigger lower deposit rates, however money market and ultra-short duration strategies with longer durations should continue to offer competitive returns for the foreseeable future. Diversification across strategies and maturities will remain important for investors to ensure they balance the need for competitive returns with security and liquidity.