The European Central Bank on Thursday cut interest rates for the first time in nearly five years, signaling the end of its hawkish policy to curb a surge in inflation.
As inflation neared the bank's 2 percent target, officials cut its three key interest rates, which apply to all 20 countries that use the euro. The benchmark deposit rate was cut to 3.75 percent from 4 percent, the highest in the bank's 26-year history and where the rate had been set since September.
“The inflation outlook has improved significantly,” policymakers said in a statement on Thursday. “It is now appropriate to reduce the degree of monetary policy restriction.”
There is growing evidence around the world that policymakers believe high interest rates have been effective in preventing economies from slowing inflation. Now, they are lowering rates, which could provide some relief to businesses and households by making it cheaper to obtain loans.
“Monetary policy has kept financing conditions restrictive,” policymakers said. “By bolstering demand and keeping inflation expectations well anchored, it has made a major contribution to bringing inflation back down.”
Europe's benchmark stock index hit a record high ahead of the interest rate cut announcement on Thursday.
On Wednesday, the Bank of Canada became the first Group of 7 central bank to cut interest rates. Recently, the central banks of Switzerland and Sweden have also cut interest rates.
More caution is being exercised in the United States, where Federal Reserve officials are waiting for more reassurance that a recent spell of stubborn inflation data will end. The Bank of England has opened the door to further rate cuts, with some officials saying rates could be cut as soon as this summer.
The ECB's rate cut on Thursday, the first since September 2019, sends a strong signal that the worst of Europe's inflation crisis is behind us. Average inflation in the eurozone rose above 10 percent in late 2022, as a surge in energy prices hit consumer goods and services, and workers demanded higher pay to ease the pain of the price surge.
The ECB has embarked on its most aggressive cycle of rate hikes in recent years. Policymakers raised the deposit rate, which banks get for storing money at the central bank overnight, to 4 percent last September, from negative-0.5 percent in July 2022.
Inflation in the eurozone slowed to 2.6 percent in May. For much of the past year, low energy prices have helped tame inflation. Food inflation has slowed to below 3 percent from more than 12 percent a year earlier.
But the central bank warned that there are still signs of strong price pressures, which means inflation will remain above the 2 percent target “well into next year.” The overall inflation rate is forecast to average 2.2 percent next year, up from the bank's forecast three months ago.
Officials face a balancing act. On the one hand, policymakers want to cut interest rates in time to avoid excessive damage to the economy from higher rates that could push inflation below their target. On the other hand, they don't want to ease policy too early, which could reignite inflation pressures.
On Thursday, ECB staff forecast that the eurozone economy would grow by 0.9 percent this year, up from a 0.6 percent forecast three months ago.
ECB President Christine Lagarde will address a press conference later in Frankfurt, and investors and analysts will be listening closely for cues about the pace of future interest rate cuts.
“The Governing Council has not committed in advance to a particular rate path,” the bank said in a statement.