ECB shouldn’t exclude second rate cut in July, Villeroy says

Governing Council member Francois Villeroy de Galhau advocates for maintaining flexibility on potential ECB rate cuts in both June and July, emphasizing a data-driven approach amidst varying opinions and market caution.

By Ahmed Azzam | @3zzamous | 27 May 2024

Market close
  • ECB should consider rate cuts in both June and July.

  • June rate cut seen as a "done deal" unless disrupted by shocks.

  • Markets expect two quarter-point reductions in 2024, down from three.

The European Central Bank (ECB) should remain open to reducing borrowing costs at both its June and July meetings, according to Governing Council member Francois Villeroy de Galhau. This stance challenges some monetary officials who are wary of consecutive cuts.

Maximum optionality

In an interview with Germany’s Boersen-Zeitung newspaper, Villeroy emphasized the need for “maximum optionality” following next month’s anticipated deposit rate reduction, which he believes can only be disrupted by an unexpected shock.

“I sometimes read that we should cut rates only once a quarter when new economic projections are available, and hence exclude July,” Villeroy said. “Why so, if we are meeting-by-meeting and data-driven? I don’t say that we should commit already on July, but let us keep our freedom on the timing and pace.”

Divergent views

While most policymakers agree on a June cut, they are generally hesitant to commit to further actions due to persistent wage gains, sticky services inflation, Middle East tensions that could elevate energy prices, and delayed US rate cuts.

Hawkish Bundesbank President Joachim Nagel suggested over the weekend that a second ECB move might have to wait until September. This cautious sentiment is also reflected in the markets, which have scaled back their expectations for monetary easing this month. They now fully price in two quarter-point reductions in 2024, down from three previously, and foresee no change in July.

Market expectations

Villeroy noted that the ECB has “significant room” to ease towards a neutral rate, which is estimated to be between 2% and 2.5%. He described market expectations of a terminal rate around 2.8% in five years as “not unreasonable.”

ECB’s approach

Speaking in Dublin on Monday, Chief Economist Philip Lane stated that the ECB is not committed to “any particular speed” of rate reductions. He reiterated that officials will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction.

US policy impact

Addressing the influence of US policy on ECB decisions, Villeroy mentioned that the Federal Reserve’s anticipated rate cuts later this year would not significantly steer the ECB. Although a stronger dollar against the euro could result, he noted that the pass-through to inflation would be less than 10%. He also suggested that tighter financial conditions from the US could be disinflationary for Europe.

Villeroy highlighted the US budget deficit as a more pressing concern, warning that it could drive long-term interest rates higher, tightening conditions and fueling inflation.

“US fiscal policy is the elephant in the room,” he said.