The European Central Bank (ECB) has cut interest rates for the first-time in five years, raising hopes that the Bank of England will follow suit.
The cost of borrowing in the Eurozone has been reduced from a record high of 4% to 3.75%, with the ECB citing progress in tackling inflation but it refused to commit to further cuts.
The ECB's decision follows Canada, Sweden and Switzerland where the central banks have all cut rates recently.
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Attention will now turn to the Bank of England and the US Federal Reserve.
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“The European Central Bank (ECB) has become the most significant central bank to start cutting interest rates, ahead of the US Fed and UK’s Bank of England,” says Ben Laidler, global market strategist for eToro.
“It’s a no-turning-back moment for the global rate-cutting cycle and especially important to supporting the burgeoning European economic and stock market recoveries.
“The $19 trillion European Union economy is the world’s second largest and the biggest to join the global interest rate-cutting path as inflation has cooled.”
Why did the ECB cut interest rates?
ECB policymakers said underlying inflation has eased, “reinforcing the signs that price pressures have weakened”. It said monetary policy has kept financing conditions restrictive, dampening demand and bringing inflation down.
However, the ECB said domestic price pressures remain strong as wage growth is elevated and it expects inflation is likely to stay above target well into next year.
It expects inflation to be at 2.8% this year and pushed up expectations for 2025 from 2% to 2.2%, meaning further rate cuts could be limited
“The [ECB’s] statement refrained from pre-committing to any future cuts and maintained a data-dependent stance,” says Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International.
“Recent upside surprises on wages and inflation are likely to keep the council members on the cautious side.
“As such, a July cut looks clearly off the table. The rate trajectory of the ECB will depend on the evolution of data from here on and the Fed, which we think will be unable to cut this year given the stickiness in US inflation."
When will the Bank of England cut interest rates?
The ECB cut may put pressure on the Bank of England to follow suit.
The next monetary policy committee (MPC) meeting is on 20 June and there are factors that could encourage rates to be cut from their 16-year high.
The rate of inflation has been getting closer to the 2% target while the latest Purchasing Managers' Index hit a six-month low in April, suggesting the restrictive policy is doing its job.
However, wage growth remains high and the Bank of England may want to avoid a June cut due to the general election on 4 July and the risk that the move looks politicised.
This could make a rate cut more likely in the next MPC meeting on 1 August.
The risk is moving too early though before inflation has settled.
Ben Nichols, interim managing director at Raw Capital Partners, says: “The outlook for energy prices is unreliable and geopolitical conflict in Europe and the Middle East could create major challenges further down the line.”
