Unless something unexpected prevents this, the European Central Bank (ECB) may introduce a small cut in euro interest rates on 6 June. This would be the first reduction in the euro interest rate since the autumn of 2019. In September 2019, ECB dropped the euro deposit rate from -0.40% to -0.50%, and then, starting from July 2022, this was followed by 10 rate hikes totalling 450 basis points.
Who supports the idea of reducing the interest rates? According to ECB itself: ‘Inflation is expected to fluctuate at approximately its current level in the coming months, and then will fall down to our target level next year. This will be driven by a lower labour cost increase, the effects of our tight monetary policy, and the waning impact of the energy crisis and the pandemic.’
But storm clouds are also on the horizon, with supply chain challenges, wars and rising energy prices (in April, oil went over USD 90 per barrel), growing, albeit more slowly, wages, and a still-high increase in service prices (at 4% annual inflation in this segment in March).
Market participants are also concerned about inflation rates in the US; the publication of these data on 10 March boosted both the dollar and long-term interest rates on both sides of the Atlantic.
Although in working out its monetary policy in the euro zone, ECB makes its decisions independently, events in the US may eventually contribute to the importing of inflation if the dollar continues to rise in value (making the importation of raw materials and other commodities, which are globally paid for in dollars, more expensive).
For the time being, however, the most likely contingency is a reduction in euro interest rates in June, which the market has been expecting for some time, as Euribor rates for all maturities have been below the ECB deposit rate (4%) since the end of last year.
If the interest rate cut is postponed, this could continue to have a negative impact on the credit market and on economic growth, especially if energy prices that the ECB monetary policy cannot influence start driving up the inflation: together with high interest rates, inflation going back on the rise would be a dangerous combination. According to ECB: ‘...the lending trend is still weak. The amount of loans banks issued to businesses grew at a slightly faster annual rate of 0.4% in February (0.2% in January). Loans issued to households remained unchanged in February (with annual growth rate of 0.3%).’
There were quiet discussions about who would be the first to lower their interest rates: ECB or the US Fed? But, the Swiss National Bank took the lead and that honour in March. In terms of the US and the euro zone, clearer predictions will be possible after the head of the US Fed press conference on 1 May.
Since the latest economic data do not support a dollar interest rate cut at the 1 May meeting, then if the ECB decides on a rate cut in June, it will be at least six days ahead of the US Fed, as its next meeting will be on 12 June.
This unofficial competition is of little importance for Latvian borrowers, but it does affect the euro-dollar exchange rate and the less popular long-term interest rates. In Latvia, it currently seems that all those who are supposed to, should have received letters from their banks (check the message section in your online bank) about the money to be received from SRS in April (will there be a clampdown on inflation in Latvia?), but for the economy to really get more momentum, a rate cut is needed, so that it boosts interest in taking new loans.
In Frankfurt, The ECB management will decide on interest rates again on 6 June, while the US Fed will next meet on 30 April/1 May.
