ECB cuts interest rates as growth dwindles

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) -The European Central Bank cut interest rates again on Thursday as inflation slows and economic growth falters, but provided almost no clues to its next step, even as investors bet on steady policy easing in the months ahead.

The ECB lowered its deposit rate by 25 basis points to 3.50% in a widely telegraphed move, following up on a similar cut in June as inflation is now within striking distance of its 2% target and the domestic economy is skirting a recession.

With the cut widely expected, investor attention has already shifted to what will come next, but the ECB shed no light as it stuck to its guidance that decisions will be taken meeting by meeting, with no pre-commitment to any particular rate path.

“The Governing Council will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction,” the ECB said in a statement. “The Governing Council is not pre-committing to a particular rate path.”

Investor attention now turns to ECB President Christine Lagarde’s 1245 GMT press conference, where she will be quizzed on the rate outlook and how expected rate reductions by the U.S. Federal Reserve may influence the ECB.

Economists think the most she will do is keep the door open to another cut in October by saying that all meetings, including the next one, are “live”.

Domestic inflation remains high as wages are still rising at an elevated pace,” the ECB said. “However, labour cost pressures are moderating, and profits are partially buffering the impact of higher wages on inflation.”

More dovish ECB policymakers, mainly from the euro zone’s south, have been arguing that recession risks are rising and high ECB rates are now restricting growth far more than needed, raising the risk that inflation could undershoot the target.

But inflation-wary hawks, who are still in a majority, say the labour market remains too hot for the ECB to sit back, and that underlying price pressures, as evidenced in stubborn services costs, raise the risk inflation could surge again.

NEW FORECASTS

New economic forecasts did little to settle the debate.

Quarterly projections from the ECB’s staff showed that growth this year will be slightly lower than forecast in June while inflation is still only seen back at target in the second half of next year.

That means few if any policymakers are likely to argue against further easing, with the key divide being how quickly the ECB should move.

Hawkish policymakers have made clear that they see quarterly rate cuts as appropriate, since key growth and wage indicators – which inform the ECB’s own projections – are compiled every three months.

Investors are also divided, with another cut by December fully priced into financial markets but the chance of an interim move in October wavering between 30% and 50%.

TECHNICAL RATE CUT

With Thursday’s move, the ECB’s deposit rate will fell by 25 basis points to 3.5%. The refinancing rate, however, was cut by a much bigger 60 basis points to 3.65% in a long-flagged technical adjustment.

The gap between the two interest rates had been set at 50 basis points since September 2019, when the ECB was pumping stimulus into the economy to avert the threat of deflation.

It announced plans in March to narrow the corridor to 15 basis points from Thursday’s meeting, to encourage the eventual rekindling of lending between banks.

Such a revival is still years away, so the ECB’s move is a pre-emptive adjustment of its operating framework.

For now, banks are sitting on 3 trillion euros of excess liquidity which they deposit with the ECB overnight, making the deposit rate in effect its main policy instrument.

Over time this liquidity should dwindle, pushing banks to borrow again from the ECB at the refinancing rate, traditionally the central bank’s benchmark interest rate.

Once that happens, the main rate will regain its headline status, while the narrower rate corridor should help the ECB better manage market rates.

The marginal lending rate, a rarely used instrument, was also cut by 60 basis points to 3.90%.

(Reporting by Balazs Koranyi; Editing by Catherine Evans)