New vitality for the Eurozone

The European Central Bank (ECB)’s reduction of interest rates, for the first time since 2019, is considered a positive “push” for the Eurozone economy, which is currently facing many difficulties.

The ECB officially lowered its key interest rate to 3.75% from 4%, marking the first cut over the past five years. This is a notable move in the context of persistent inflationary pressure in the 20-country Eurozone. According to the ECB, inflation in this region in 2024 and 2025, will be higher than expected, reaching 2.5% and 2.2% respectively, up from the previous forecast of 2.3% and 2%. In an interview with Financial Times, ECB chief economist Philip Lane said that the bank’s policymakers need to keep interest rates within a limited range this year, to ensure that inflation continues to decline and is not “stuck” above the target level.

The ECB emphasised, that an interest rate cut is necessary to support economic growth and ensure that inflation is maintained near the central bank’s target of 2%. The ECB’s governing council stated, that based on an updated assessment of the outlook and factors affecting inflation, as well as monetary policy, the council believed that it was time to adjust the restrictive level of monetary policy, after nine months of keeping the interest rate stable.

Some observers pointed out that this week's ECB’s interest rate cut was unusual, as the ECB only launched such monetary easing in response to a crisis, such as after the collapse of Lehman Brothers bank in the US in 2008, or when Greece needed a series of bailout packages in 2011. The ECB’s most recent interest rate reduction in September 2019, was to respond to the weakened growth and declining inflation below the 2% target.

In its biannual Financial Stability Review, the ECB said that economic conditions have improved compared to the previous six-month assessment, and the economic picture has become brighter, but the outlook remains fragile. According to ECB Vice President Luis de Guindos, the risk of a severe recession in the short term, along with rising unemployment rates, has decreased significantly at present. Meanwhile, an assessment of financial stability six months ago, showed that rising unemployment was still a major concern for many countries in the region.

According to the ECB, the above improvement is thanks to the Eurozone’s inflation slowdown, at 2.4% in April, close to the 2% target. However, Luis de Guindos warned that the economic outlook is still not positive in the context of geopolitical tensions with conflicts in Ukraine and Gaza, which not only pose risks to Eurozone financial stability but also global financial stability.

In its report, the ECB noted that increasing geopolitical tensions could affect energy supplies, increase inflation and erode investors’ confidence in economic growth prospects. In addition, economic policymakers globally are still uncertain about policy direction amid a series of elections in 2024. The report also said tightening financial conditions continue to weigh on the more vulnerable groups of households, businesses and governments in the Eurozone. The real estate market, especially the commercial sector also continues to decline.

To support the economy, last year the ECB raised deposit interest rates to a record 4%. Accordingly, the Eurozone economy showed signs of recovery in the first quarter, when the bloc’s GDP increased by 0.3% compared to the previous quarter, and ended a year of stagnation. For inflation to fall to the 2% target by next summer, the Eurozone needs a combination of slowing wage growth, rising labour productivity and falling corporate profit margins. According to Hollingsworth, chief economist at Germany’s Berenberg Bank, to support the economy in recovering stable growth and achieving the inflation target of 2%, the ECB needs to effectively use interest rate policy regarding Europe’s housing market, investment sectors and consumer spending.

According to analysts, by lowering interest rates again, the ECB is preparing to breathe new life into Europe’s housing market, business investment and consumer spending.

NDO