ECB diverges from Fed on rates, sparking jitters

BERLIN, Germany — In a rare move, the European Central Bank last week beat the US Federal Reserve to the monetary policy easing punch when it cut interest rates for the first time in nearly five years.

AFP looks at why it was the first to act and whether the divergence holds any risks.

Why did the ECB move ahead of the Fed?

The central bank for the 20 countries that use the euro cut its key deposit rate from a record 4 percent to 3.75 percent, citing progress on fighting inflation that has fallen sharply and is heading towards its two-percent target.

Canada’s central bank also cut its benchmark rate last week, while policymakers in Sweden and Switzerland recently started easing policy.

But the Fed, which publishes its latest rate decision on Wednesday, still faces stubborn inflation and a robust labor market, which have pushed back expectations for when it will begin to reduce borrowing costs.

US policymakers are expected to keep rates unchanged at a 23-year high, with analysts predicting they will not start cutting before September at the earliest.

Will monetary policy diverge even further?

ECB President Christine Lagarde said in an interview with European media this week that the two central banks had to act “on the basis of our respective mandates, and we have different fundamentals at the moment”.

But the differences in rate paths could end up being less extreme than anticipated even just a few months ago — eurozone economic data has been coming in stronger than expected, tempering expectations of how fast the ECB will move.

After cutting last week, Lagarde struck a cautious tone, saying it was hard to predict the path ahead and it would likely be “bumpy”.

Analysts are now betting a cut once a quarter — so at every other meeting of the ECB, which makes its rate calls every six weeks — but also noted that the ECB could go slower, depending on the data.

What consequences for the euro?

If US interest rates remain higher it will likely boost bond yields, particularly on 10-year Treasury bonds, and make the dollar more attractive to the detriment of other currencies.

After the ECB’s rate cut last Thursday, the euro fell to around $1.07 after trading for weeks at around $1.09.

If the Fed holds rates steady Wednesday, it would be “logical for the euro to weaken against the dollar”, said LBBW bank analyst Jens-Oliver Niklasch.

But analysts say the impact would be limited as most traders had already anticipated the divergence.

“Since February at least, the markets have taken this paradigm shift on board,” said independent markets analyst Andreas Lipkow.

And for the economy?

Even if limited, the fall in the value of a currency can help economies by lowering the price of goods exported to countries that use different currencies to pay for them.

That could be welcome in export-oriented Germany, as Europe’s biggest economy has struggled in recent times with high energy costs and weakness in trading partners battering its crucial manufacturers.

“Particularly in these difficult economic times, a euro that is weaker than the dollar could give exporters a boost,” said Volker Treier, an economist with the national association for the German chambers of commerce (DIHK).

But a weaker euro could increase the cost of imports, particularly those denominated in dollars, and increase inflation in the eurozone — though the ECB has downplayed such concerns.

“More and more global firms who want to sell to the (euro) area, they set their prices in euros,” ECB chief economist Philip Lane said in Dublin on Tuesday.

The exchange rate between the euro and dollar remains “incredibly stable”, and recent fluctuations would be of interest to currency market specialists but “invisible” when it comes to calculating inflation, Lane said.