The ECB governing council, the bank’s rate-setting body, said it was “appropriate” to ease rates since price pressures were gradually diminishing.
The move came even as ECB officials raised their inflation forecast and warned that wages were increasing at an “elevated” rate. Prices are now expected to rise this year at an annual rate of 2.5 percent, compared with a March forecast of 2.3 percent.
But months of steady progress convinced policymakers that a modest reduction in borrowing costs was warranted, ECB President Christine Lagarde said in Frankfurt. Much of the increase in euro zone wages represents labor contracts intended to compensate for the past few years of fast-rising prices, rather than an ongoing trend, she said.
Even after today’s action, interest rates will remain a drag on the economy. The ECB governing council vowed to bring annual inflation back to 2 percent in “a timely manner.” Lagarde reiterated her stance that European authorities will decide future rate moves at each of their scheduled meetings based on the latest economic data.
Fresh shocks from the wars in Ukraine and the Middle East could jolt energy and freight markets, unsettling expectations of a gradual improvement in prices.
“We know it’s going to be a bumpy road,” she told reporters.
Bank officials said they also have become slightly more optimistic about growth prospects. This year, the euro area economy is projected to expand at an annual rate of 0.9 percent, up from the March forecast of 0.6 percent.
There was little immediate reaction in financial markets to the ECB move, which Lagarde had telegraphed for months. The value of the euro was little changed at around $1.09.
“It’s always significant when the first major central bank starts cutting rates. We’ve seen it from some of the smaller ones in emerging markets, but it is sort of a milestone when you get one of the big boys moving,” said Eric Winograd, director of developed market economic research for AllianceBernstein. “It is a foreshadowing of what we expect from other central banks.”
Indeed, investors remain anxious for the Federal Reserve to join the parade. As the year began, markets expected the Fed to lower rates seven times in 2024. But inflation, while down significantly from its mid-2022 peak, remains higher than the Fed’s 2 percent target for price stability.
Almost no one expects the Fed to cut when its policymaking committee meets June 12. But there is a 70 percent chance of a Fed cut in September, according to CME FedWatch, which tracks investor bets in the futures market.
European interest rates have followed an extraordinary trajectory over the past decade. Amid chronic economic weakness, the ECB lowered its benchmark rate into negative territory in 2014 and held it there until the post-pandemic surge of inflation. Then European monetary authorities raised rates nine times, eventually reaching a record high of 4 percent in September.
Europe’s inflation problem in recent years was largely driven by higher energy prices, following Russia’s invasion of Ukraine. Those costs have ebbed. But growth in the 20-nation euro zone has lagged. Since the start of 2022, the size of the U.S. economy has grown by 4.7 percent compared with just 1.7 percent in Europe, according to TD Securities.
ECB officials are likely to pause before implementing additional rate cuts, according to Jacob Kirkegaard, an economist with the Peterson Institute for International Economics.
“They’ll wait and see — possibly cut in September, possibly cut three times in 2024,” he said.
The ECB action came one day after the Bank of Canada became the first member of the Group of 7 democracies to lower rates. In its first cut since 2020, the Canadian central bank dropped its policy rate by one-quarter of a percentage point to 4.75 percent.
“We’ve come a long way in the fight against inflation,” said Tiff Macklem, governor of the Bank of Canada.
Further rate cuts are likely if inflation continues to decline. But progress in eradicating inflation is likely to be “uneven,” Macklem said.