ECB takes small step towards rate cut as inflation falls

ECB takes small step towards rate cut as inflation falls

The European Central Bank kept borrowing costs at record highs on Thursday but took a first, small step towards lowering them, saying inflation was easing faster than it anticipated only a few months ago.

Having underestimated a sudden surge in prices two years ago, the central bank for the 20 countries sharing the euro has been reluctant to declare victory over what turned out to be the most brutal bout of inflation in decades.

Leaving its main interest rate unchanged at 4.0% as expected, the ECB tweaked its message slightly to reflect a continued fall in inflation over the past 1-1/2 years and new, lower economic projections.

"Since the last Governing Council meeting in January, inflation has declined further," the ECB said in a statement. "Although most measures of underlying inflation have eased further, domestic price pressures remain high, in part owing to strong growth in wages."

Having managed to talk traders out of betting on a rate cut in early spring, the central bank studiously avoided making any promises on Thursday.

It reaffirmed instead that future decisions would partly depend on the path of underlying inflation, which strips out more volatile prices and has proven particularly stubborn.

At a 1345 GMT press conference, ECB President Christine Lagarde is also likely to repeat that she and her colleagues need more evidence that wage increases will not give inflation another leg up.

Sources have been telling Reuters for months that the ECB is unlikely to reduce borrowing costs before its June 6 meeting as crucial data about wages will only become available in May.

This gives the ECB another meeting - on April 11 - to explicitly open the door to what ECB Chief Economist Philip Lane has said is likely be the first in a series of rate cuts.

Investors have pencilled three or four cuts to the 4% rate the ECB pays on bank deposits this year, taking it to 3.25% or 3.0% <0#ECBWATCH>.

LOWER INFLATION AND GROWTH

In its quarterly economic projections, the ECB cut its forecast for inflation this year from 2.7% to 2.3%. That could mean the central bank hits its 2% goal this year, rather than in 2025 as it has expected.

Inflation has been coming down for nearly 18 months and it was 2.6% in February.

This was partly the result of a steep fall in fuel costs, which had been boosted by Russia's invasion of Ukraine, but also reflected the ECB's steepest ever increase in borrowing costs, which has brought lending to a standstill.

But underlying inflation excluding volatile food and fuel prices was still at 3.1% and an index for the price of services, which are closely linked to wage growth, rose by nearly 4%.

"Disinflation is going much quicker than we expected on the headline level but we can't be certain yet about core inflation because wage developments remain unclear," ECB policymaker Peter Kazimir told Reuters in a recent interview.

His German colleague - and fellow policy hawk - Joachim Nagel also said the ECB should resist the temptation to make an early rate cut, and wait for wages data.

The policy tightening has taken a toll on economic growth, which has been stagnating and is likely to continue to be weak.

The ECB now expects the euro zone's GDP to expand by 0.6% compared to 0.8% in its last round of projections in December.

Flagging growth and inflation has led several members of the ECB's policy-making Governing Council, including Spanish central bank chief Pablo Hernandez de Cos, to start talking about an upcoming rate cut. Greece's Yannis Stournaras has pointed to June as a likely date.