The European Central Bank (ECB) left its key deposit rate unchanged at 3.75 percent, as expected but indicated that a second interest rate cut is quite possible at its next meeting in September. 

ECB President Christine Lagarde, who has tended this year to talk up the prospect of an economic recovery driven by domestic demand, warned at her regular press conference that the risks to growth are skewed to the downside. 

She said 2024 would be a year of “muted growth, accompanied by heightened uncertainty,” and played down the recent ‘stickiness’ of inflation, saying that it was mostly due to one-off factors.  

The euro, which had initially failed to react much, ultimately slipped a quarter of a cent against the dollar on perceptions that further rate cuts were very much in the pipeline. Eurozone government bond yields also fell, especially shorter-dated ones which are more sensitive to the outlook for ECB rates. The yield on Italy’s benchmark two-year note hit a six-month low of 3.09 percent. 

Trade war risks flagged

At a time when the EU is facing the risk of a trade war on two fronts next year with the U.S. and China, Lagarde took two opportunities to flag risks to the export sector, habitually an important engine of growth for the region. 

According to ECB data, eurozone exports in the first quarter of this year were down over 4 percent from a year ago, against a backdrop of slowing demand in the U.S. and the long-term impacts on energy-intensive manufacturing from the loss of cheap Russian natural gas.  

Aside from those factors, Lagarde also hinted at unhappiness with the way that China has grabbed market share from Europe as it has sought to export its way out of its own economic slump, caused by the deflation of a property bubble. The yuan has devalued by some 13 percent against the euro in the last two years, sharpening China’s competitive edge on world markets.

Exports are “a domain that we will also be looking very carefully at, to see how the numbers are faring going forward,” Lagarde said, with a close eye on “the competitive position of the European Union and the euro area relative to other economic nations — in particular, China.”

No promises

Lagarde took pains not to promise any fresh easing of monetary policy, having been embarrassed in June by a string of economic data that barely justified the Bank’s first interest rate cut since the pandemic. Instead, she stressed the Bank’s determination to keep “a data-dependent and meeting-by-meeting approach”, and said the outcome of its next meeting in September was “wide open” — even though financial markets are all but certain of a second quarter-point cut.

“Today’s lack of action does not mean … that the easing cycle has come to a halt,” said Samuel Adams, European economist with UBS Global Wealth Management, arguing that the ongoing trend of disinflation should allow another cut in September, and a further cut each quarter thereafter. However, Carsten Brzeski, ING’s Global Head of Macro, saw a September cut as a toss-up.

Thursday’s decision had been widely expected after the central bank cut interest rates from a record high in June. While analysts agree that the current level of interest rates is restrictive, with the deposit rate more than a full percentage point above current inflation, they say that the ECB is able to err on the side of caution because unemployment unusually low for this stage of the economic cycle: it stayed at a euro-era low of 6.4 percent of the workforce in May. As such, they argue, the Bank is only to cut at meetings when it has a fresh set of economic forecasts. The next updates are due in September and December.

Contrary to some expectations, Lagarde was not quizzed particularly hard by journalists about the situation in France, where this month’s election produced a parliament dominated by parties that have opposed President Emmanuel Macron’s attempts to cut a yawning fiscal deficit. The country is still awaiting a new government. Lagarde, for her part, gave only boilerplated answers on the subject, applicable to all eurozone member governments.