The anticipation of interest rate cuts by the European Central Bank (ECB) has garnered significant attention recently, primarily due to the changes within the Eurozone's inflation landscapeMany financial institutions are predicting that the ECB will initiate a new cycle of rate cuts as early as June, positioning itself to be the first major central bank in the West to take such actionIf these predictions prove accurate and the ECB maintains a stable outlook as it cuts rates, the economy within the Eurozone is likely to show signs of gradual improvement.

Historically, during the last cycle of interest rate increases conducted by major central banks, the ECB faced criticism for its delayed response, which attributed to a surge in inflationNow, as the tide shifts—most central banks poised to lower rates—the ECB appears ready to reverse its course and reduce interest rates first among Europe’s major economies.

This expectation is rooted in macroeconomic fundamentalsData indicates that the ECB has adequate support to commence rate cutsAfter ten consecutive increases in its benchmark interest rate, the ECB has maintained a holding pattern since the third quarter of last year, with overall interest rates positioned in a restrictive zoneWhile the neutral interest rate for the Eurozone is projected to be half or lower than the current deposit rate, economic growth has stagnated over the past yearAlthough recent leading indicators suggest some improvement, the economic outlook still faces challengesThe lingering justification for maintaining a tight monetary policy lies in inflation being above target levels; nevertheless, the inflation scenario is experiencing a rapid shift.

In contrast to other regions, particularly the United States, where the consumer price index (CPI) rose by 3.5% year-on-year as of March, the Eurozone demonstrates greater resilience against inflationThe Eurozone's CPI peaked at 10.6% in October 2022 and subsequently declined consistently to 2.4% by November 2023. Despite a brief uptick to 2.9% in December 2023, the inflation rate fell again at the start of 2024, continuing a downward trend for three consecutive months to 2.4% by the end of March.

This evolving inflation narrative has recently been echoed in statements from the ECB's monetary policy meeting in April, affirming expectations for a timely interest rate cut

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The ECB's decision aligns with market predictions and provides clearer insights into its future monetary direction.

During the April meeting, the ECB unsurprisingly chose to keep its benchmark interest rate unchanged; however, the future guidance regarding its policies proved more significantOver the last year, the ECB has consistently highlighted three critical factors influencing future monetary policy: the latest assessment of inflation prospects, dynamics of underlying inflation, and the effectiveness of monetary policy transmissionThe latest meeting underscored these assessments, revealing a dovish stance that supports the market’s previous anticipation of rate cuts.

The ECB conveyed that since the March meeting, its perspective on inflation and growth remained unchangedIt articulated that if the Governing Council were to reassess the latest developments on inflation forecasts, core inflation dynamics, and policy transmission, the takeaway would reinforce confidence in convergence towards the inflation target, thus justifying the need to reduce current restrictive monetary levels.

In its specific evaluations, the ECB noted that recent macro data generally affirmed its previously established mid-term inflation outlookWhile the indicators of underlying inflation are showing signs of slowing, one persistent challenge remains—the inflation and price pressures within the services sector, which still hover around 4%. High service sector inflation risks upward pressure on overall inflation; however, the ECB believes that businesses are absorbing some of the increased labor costs through profitsMeanwhile, ongoing financial tightening from previous rate hikes continues to suppress demand and exacerbates the downward pressure on inflation.

In contrast to the technicalities of the meeting, ECB President Christine Lagarde’s comments were candid and unambiguousIn a subsequent press conference, she appeared to play down the significance of services sector inflation and its potential impacts on monetary policy

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When questioned whether high inflation in services could lead to problems, she stated, “We won’t wait for everything to return to 2% before taking action.” Additionally, Lagarde remarked that some members of the Governing Council expressed “sufficient confidence” in the case for a rate cut during this meeting, pointing out that by June, the ECB would have more data to inform its decisionShe reiterated that the council would also possess new macroeconomic forecasts.

Consequently, most institutions now believe that barring any unforeseen circumstances, the ECB is likely to embark on a new cycle of rate cuts in JuneWith the expectation that the Federal Reserve will delay its own cuts and the Bank of England facing challenging balancing acts, the ECB is positioned to be the frontrunner among major Western central banks in this regard.

However, it is crucial to note that while the anticipation of the ECB being the first major central bank to cut rates is gaining traction, there remains a possibility of delays or moderated rate cutsCurrent risks surrounding the ECB's expected rate cut cycle stem from potential fluctuations in macro dataRecently, the U.S. has witnessed sudden shifts in employment and inflation data, leading to delayed inflation expectationsWhether similar developments will emerge within the Eurozone continues to capture the attention of expertsThe forthcoming data on wage growth for the first quarter, along with consumer price index readings for April and May, will undoubtedly be critical indicatorsLagarde has precisely emphasized that the path of the ECB’s policy rate is “data-dependent.”

Another risk factor emanates from the situation in the U.SAs inflation data in the United States rises and the expectations for rate cuts from the Federal Reserve diminish, Lagarde declared during the press conference that the ECB is prepared to chart its path, emphasizing reliance on "data" rather than being influenced by the Fed

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This stance indicates that a degree of divergence in monetary policy between the Fed and the ECB is likely to emerge, while also underscoring the ECB's commitment to maintaining its autonomyNevertheless, compared to the earlier expectation of synchronized easing with the Fed, changes in the Federal Reserve's strategy might prompt the ECB to adopt a more cautious and tempered approach than previously anticipatedAfter all, being the first to act could result in greater depreciation pressure on the euro, leading to increased import costs and heightened inflation pressures—factors that the ECB must weigh carefully.

Despite the relatively stable expectations around the ECB’s interest rate cuts, some market institutions have adjusted their forecasts, lowering the expected total cuts for the year from 125 basis points to 100 basis points since the previous March assessment.

Regardless of how it unfolds, the impending rate cuts are viewed as a significant boost for the struggling Eurozone economyThe latest Sentix Investor Confidence Index reveals that while the most recent April data still resides in negative territory, it has reached its highest level since April 2022.

Further illustrating this changing economic landscape, the recent Purchasing Managers' Index (PMI) for the Eurozone indicates that the economy may be approaching a turning pointThe composite PMI for March surged to its highest level since June 2023, breaching growth thresholdsConversely, the manufacturing PMI stood at 46.1, falling short of the anticipated 47, suggesting ongoing challengesNotably, Germany, a key player in Eurozone manufacturing, has experienced its composite PMI remaining in contraction territory for nine consecutive months, with the most recent figures falling significantly below the growth line, highlighting a worrisome trend for the manufacturing sector that hampers the overall economic prospects of the Eurozone.

However, the expected arrival of rate cuts is likely to lead to relaxed bank credit conditions and an overall improvement in financing availability, which will subsequently boost household consumption and corporate investment across the Eurozone

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