ECB Plans June Rate Cut Amid Fed's Dollar Dominance

Key Takeaway

• ECB's Holzmann acknowledges the Fed's significant influence due to the dollar, impacting ECB decisions.
• The ECB plans a quarter-point rate cut on June 6, diverging from the Fed's strategy.
• Rate cuts are contingent on meeting the inflation target by mid-2025, with new data expected in September and December.

ECB Eyes Rate Cuts Amid Fed's Stance

European Central Bank (ECB) Governing Council member Robert Holzmann highlighted the significant influence of the Federal Reserve on global monetary policy, acknowledging the Fed's role as a dominant force in the financial world. The ECB is preparing to reduce interest rates by a quarter point on June 6, a move that contrasts with the Fed's likely strategy to maintain higher borrowing costs. Holzmann, known for his hawkish views, emphasized the importance of meeting the ECB's inflation target by mid-2025 before proceeding with rate cuts, cautioning against hasty monetary easing.

Transatlantic Divergence in Monetary Policy

The impending divergence between European and US interest rates is becoming more pronounced. Despite Federal Reserve Chair Jay Powell's less hawkish stance than anticipated, the gap in interest rates across the Atlantic is expected to widen. ECB President Christine Lagarde stressed the ECB's data dependency, distancing the bank's policy decisions from the Fed's influence. However, the potential for a growing gap raises concerns among European central bankers, with varying opinions on the impact of sustained higher Fed rates on the Eurozone.

Market Expectations and Currency Implications

Financial markets anticipate a significant interest rate differential between the ECB and the Fed by the end of 2024, with expectations of a 1.8 percentage point gap. This divergence is not mirrored in the UK, where market expectations for the Bank of England (BoE) and the Fed have aligned more closely. Despite these expectations, currency markets have not shown large movements, suggesting a limited impact of interest rate differentials on the euro's value. The ECB's analysis indicates that exchange rate fluctuations have a relatively small effect on inflation and GDP within the Eurozone.

Street Views

• Robert Holzmann, European Central Bank Governing Council (Neutral on interest rate decisions):

  "To a certain extent, our data and decisions are naturally influenced by the Fed... We don’t operate in a vacuum. The Fed with the dollar is, figuratively speaking, the gorilla in the room." "First of all, the basic prerequisite for the first rate cut must be met, namely that there is a high probability that we will reach our inflation target by mid-2025... But I see no reason at all for us to cut key rates too much too quickly. Every step we take is dependent on the data available at that time."