In brief
- At the conclusion of its June monetary policy meeting, the European Central Bank (ECB) cut its three key policy rates by 25 basis points (bps).
- Governing Council indicate the policy rates are “in the right place” - potentially lining up a rate hold in July, pending no data shocks.
- Near term inflation has been revised lower.
An almost unanimous decision
At the conclusion of its latest monetary policy meeting, the ECB cut all of its policy rates by 25bps. From 11 June, the Marginal Lending Facility will fall to 2.40%, the Main Refinancing Rate will be 2.15%, and the Deposit Facility Rate (DFR) will be 2.00%.
Just one GC member dissented against today’s decision , later revealed to be known hawk, Robert Holzmann.
Near term inflation forecasts cut, but viewed as temporary
Erratic trade policy from the US Administration has seen the euro strengthen by 3% since March coupled with a decline in the price of oil by 10%, over the same period. These factors are the main drivers behind the ECB’s downward revision to inflation forecasts for this year and next, with headline inflation 0.3% lower than in March, at 2.0% and 1.6% respectively. This disinflationary development is viewed as temporary with a return to the target 2% level by 2027.
The ECB also provided alternative forecasts based on mild and severe scenarios concerning trade outcomes. The mild scenario would bring a significant improvement to growth, with a lesser impact to inflation, while the severe scenario would see both growth and inflation lower.
Clearly a lot of uncertainty remains as to how trade negotiations play out, with the outcome likely to have a significant influence on the ECB’s next steps.
What will the ECB do next?
The ECB are likely very close to the final rate cut, in this current cycle and with the Governing Council feeling confident that the policy rates are at the correct level, then this would imply they are hoping to leave policy rates unchanged at their July meeting. Data remains key, so any prints that fall outside of the expected numbers, may require the ECB to take further action. September will provide the next set of staff projections, so the final rate cut could occur at this point.
Market reaction and fund positioning
The latest cut was fully priced in, well before the ECB began their discussions. The second and potentially final 25bp cut, is close to being fully priced by the end of 2025. Over the past two months, the trough in rates being priced by the market has at times got as low as 1.5%, which we would view as only justified in a more recessionary environment. With many issuers lowering term levels, the value of extending duration has diminished and accordingly the Weighted Average Maturity (WAM) target on our Euro Low Volatility Net Asset Value (LVNAV) strategy has been reduced to a 35 to45 day range. This leaves us with plenty of room to take advantage of any back up in rates. We continue to hold a core position in floating rate product which helps sustain current yield, especially if the ECB are minded to pause rate cuts.
Conclusion
The seventh consecutive interest rate cut has brought the ECB’s Deposit Facility Rate to the lowest level in 2.5 years. We believe that there will be one further rate cut, in this cycle, likely to occur in September, following a pause in July. This will still leave cash rates at healthy positive levels, versus recent history.
For euro cash investors, the rate cut will trigger lower deposit rates at the start of the next Reserve Period (11 June). However, step-out money market fund strategies with longer durations will shield investors from the full impact of lower rates in the medium term.