Central bank update: ECB cuts as expected, so why the sell-off?

Market conviction of a rate cut from the European Central Bank (ECB) going into their June Monetary Policy meeting was all but certain; previous signalling was clear and, absent a very significant surge in recent inflation data, a cut of 25bps (0.25%) across the ECB’s key interest rates was seen to be a done deal.

The ECB duly followed through on this, but the market reacted by selling off in the immediate aftermath, with yields across European government bond markets increasing by 5-10 basis points. Why was this? The devil was in the detail – in this case a revised set of growth and inflation forecasts from ECB staff members. Headline inflation for 2024 was revised up from 2.3% in March to 2.5%, with forecasts of core inflation also increased by 0.2%. Forecasts for both headline and core inflation for year 2025 were also raised (though 2026 forecasts remained unchanged). It felt like the ECB had put itself in a situation with very little choice but to cut rates as not doing so would have involved a big loss of face, credibility and raise questions over confidence in their own ability to return inflation to their 2.0% target. The wording accompanying the change in monetary policy was also somewhat opaque on the direction and pace of future changes to monetary policy, once again stating that the “Governing Council is not pre-committing to a particular rate path.”

Given that revised inflation outlook, accompanied by stronger growth forecasts, why did the ECB feel the need to cut rates here and now?

This was the tone of a number of questions posed to ECB President Lagarde at the accompanying press conference. Perhaps lacking some of the clear and concise direction we have (now) got used to in addressing journalists, Lagarde was unwilling to provide further guidance as to when the next cut can be expected (not forcefully pushing back on July, despite having the opportunity to do so and markets already pricing out that probability).

Instead, she focused on what had been achieved in the battle against inflation so far. She vociferously challenged the assertion that perhaps the ECB had softened in its stance on addressing above-target inflation and highlighted that in the two periods defined by raising rates and then holding rates at a restrictive level, inflation had been halved under each regime. As regards the revisions higher to headline and core Inflation in the ECB Staff forecasts, Lagarde pointed towards one specific forecast point, the fourth quarter of 2025, which had remained reasonably stable, and this was the key timeframe that they were focused on – where inflation settles at the end of next year. Lagarde made it clear that the path to this point may well be “bumpy” and there could yet be a few more surprises along the way, but the destination needs to be the focus, more so than the journey itself.

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