Could ECB Rate Cuts Beat the Fed to the Punch?

Although markets expect both the Fed and the ECB to cut rates in June, macro developments could change that forecast.

As inflation continues to ease across the developed world, markets are eager for the rate-cutting cycle to begin. The US Federal Reserve and European Central Bank (ECB) will review monetary policy at their June meetings, and investors expect both to start cutting at that stage. That’s a realistic central case, in our view, based on published economic data.

But another factor could influence the batting order: each central bank has its own specific mandate that determines its policy response to changes in the economy.

The US economy—particularly labor markets—remains strong, prompting concerns that US inflation won’t fall as fast as expected and that the Fed may delay its first cut, perhaps for some time. In those circumstances, would the ECB stand still?

Varying Mandates Create Different Motivations

While the Fed’s dual mandate includes both inflation and unemployment targets, the ECB is mandated to focus exclusively on price stability, keeping inflation near but below 2%. So, we think the ECB would likely cut rates if the Fed were to delay the start of its cutting cycle, as long as euro-area inflation stays on a sustainable downward course toward the target.

The ECB’s decision-making should follow three principles. Essentially, the governing council must evaluate: 1) how effectively monetary policy is working to curb inflationary pressures; 2) if the underlying core components of inflation are falling and; 3) the outlook for inflation, based on available data.