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Interest rates are coming down in Europe. The Fed won’t follow yet

By Hanna Ziady, CNN

London (CNN) — The European Central Bank cut interest rates Thursday, moving before the US Federal Reserve and the Bank of England to lower borrowing costs as inflation recedes following years of rate hikes.

The first ECB rate cut in nearly five years takes the benchmark rate in the 20 countries that use the euro down to 3.75% from an all-time high of 4%, where it had stood since September.

The move will bring some relief to companies and consumers, many of whom have felt the financial strain of the rapid run-up in interest rates since late 2021.

But the ECB cautioned that the fight to control price rises wasn’t completely over yet and that it wasn’t yet committed to further rate cuts.

“Despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year,” the central bank said in a statement.

Speaking to journalists, ECB President Christine Lagarde — who donned a necklace in the shape of the words “In charge” — emphasized that the central bank would continue to follow “a data-dependent and meeting-by-meeting approach.”

“We are not precommitting to a particular rate path,” she said.

Major central banks started raising borrowing costs as inflation soared, driven higher by the end of the pandemic and the energy shock caused by Russia’s invasion of Ukraine.

Price rises in the eurozone, the United States and the United Kingdom have since slowed, bringing the annual inflation rate down from its peak between 9% and 11% toward the 2% targeted by the respective central banks.

The ECB’s decision follows a rate cut by the Bank of Canada Wednesday, which became the first G7 central bank to reduce borrowing costs in the past few years. Central banks in Switzerland and Sweden have also cut interest rates this year.

Traders are all but certain the Fed will keep rates on hold at its meeting next week, and again in July. The Bank of England is likewise not expected to cut rates at its meeting on June 20, which comes just weeks before the UK holds a general election.

Ahead of the Fed, but not in a hurry

Although the ECB has fired the starting gun on rate cuts, analysts think it could stand still at its next meeting in July.

“This is not a central bank in a rush to ease policy,” said Mark Wall, chief European economist at Deutsche Bank, describing the ECB’s tone as “hawkish” despite Thursday’s cut.

Eurozone inflation ticked up more than expected in May, to 2.6% from 2.4% the previous month. Core inflation, which strips out volatile food and energy prices, also accelerated as wages grew rapidly.

On Thursday, the ECB raised its inflation forecast for this year, to 2.5% from the 2.3% predicted in March. It added that it would keep interest rates “sufficiently restrictive for as long as necessary” to return inflation to the 2% target.

The European economy, which only narrowly avoided a recession last year, is showing signs of recovery, which could prop up inflation.

In May, combined output in manufacturing and services hit a 12-month high, according to a survey of purchasing managers compiled by S&P Global and Hamburg Commercial Bank. Business confidence, meanwhile, reached its strongest level in more than two years and unemployment is at a record low.

The ECB upgraded its forecast for this year’s economic growth in the eurozone to 0.9% from the 0.6% projected in March.

Another factor that could influence the central bank’s thinking going forward is the timing of rate cuts by the Fed, which are expected later this year. Policymakers in Frankfurt may be hesitant to move too far ahead of their US counterparts as that could cause the euro to lose value against the dollar, which could then push up inflation in Europe by raising the price of imports.

Higher interest rates tend to attract more international capital flows into a country, boosting demand for its currency.

This article has been updated with additional information.

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