The European Central Bank is set to take the lead in cutting interest rates ahead of the U.S. Federal Reserve, marking the eurozone as the largest rich-world economy to initiate easing borrowing costs for businesses and consumers. The move comes as inflation, triggered by Russia's full-scale invasion of Ukraine, gradually recedes.
ECB President Christine Lagarde and other officials have indicated a likely quarter-point rate cut from the current record high of 4% when the bank's governing council convenes in Frankfurt, Germany. Lagarde expressed confidence in controlling inflation in the eurozone, comprising 20 European Union countries that use the euro currency.
This shift in monetary policy contrasts with the initial response to the inflation surge, where the Fed led by raising rates in March 2022, while the ECB followed suit about four months later. Central banks globally are now leaning towards lowering interest rates, with several smaller economies having already implemented rate cuts.
The inflation surge in Europe was primarily driven by Russia's disruption of natural gas supplies and supply chain bottlenecks as the global economy recovered from the COVID-19 pandemic. The resulting energy price spike has subsided, with inflation dropping to 2.6% in May, nearing the ECB's 2% target.
On the other hand, the U.S. economy faces inflation fueled by government stimulus and pandemic recovery spending, with the consumer price index at 3.4%. The Fed anticipates rate cuts from the current benchmark level of 5.25%-5.5% but is not expected to make changes at its upcoming policy meeting.
Lowering interest rates can help combat inflation by reducing demand and easing price pressures. However, high rates can impede growth, which has been limited in the eurozone. Economic output has shown minimal growth, with a modest increase of 0.3% in GDP in the first quarter of the year.
The ECB's potential rate cut is expected to have implications on borrowing costs, impacting mortgage rates, credit card charges, and stock prices. Lower rates may stimulate economic activity but could also affect sectors like construction and renewable energy production, which are sensitive to borrowing costs.
