Cut

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European Central Bank (ECB) officials, led by President Christine Lagarde, have reduced the key deposit rate by a quarter-point to 3.75%. This decision follows a marked improvement in the inflation outlook. However, the ECB plans to maintain restrictive policy rates for as long as necessary. The rate cut, described as a "hawkish ease," required an agreement to raise inflation expectations to secure votes for this move. The timing of the ECB’s next move remains uncertain. With the disinflationary process firmly underway, the ECB, along with other central banks, is expected to gain confidence in easing policy further. This rate cut is significant for the ECB as it marks the first time in two decades that policymakers are initiating a monetary-easing cycle without a financial emergency forcing their actions. Instead, investor confidence in the euro area is keeping yields stable.

Despite a seemingly calm surface, underlying economic issues that have been building for decades are becoming apparent. The euro zone continues to struggle with sluggish growth, weak productivity, unfavorable demographics, and high public debt in key countries. This period of benign markets and economic recovery offers a rare opportunity for Brussels and national governments to address these challenges. However, with European elections on the near horizon, there is a risk that politicians may not capitalize on this chance to implement growth-enhancing reforms and improve public finances, potentially leading to further decline in the region's global relevance. The eurozone urgently needs a re-industrialization to match the pace of the US and emerging markets. Without significant and courageous policy moves, the European Union risks diminishing its global influence, leaving the US and China to vie for economic supremacy. Weak productivity and low potential growth continue to be significant issues that must be addressed for long-term stability and prosperity. Since the beginning of the 21st century, the EU has consistently underperformed the US in these areas. Slower improvements in living standards and a decline in global economic power are the outcomes. The gap between the European and US economies since 2000 reached about 18% of potential GDP in 2023, equivalent to more than €3 trillion, according to Bloomberg Economics, with projections suggesting the shortfall could reach almost 40% by 2050. Currently, the euro region is at a pivotal moment. The ECB's rate cut coincides with the end of the worst inflation bout in the currency's history and a surprising growth surge following a shallow recession. The spread between Italian and German bonds, a key risk measure, narrowed to a two-year low in early 2024. Although yields have risen slightly as investors reassess the ECB’s capacity for further cuts given the resilient economy, there are no signs of the fragmentation fears that troubled the market before the first hike in 2022. The euro zone's policy environment has become more cohesive, now incorporating the European Union's unprecedented pandemic-era recovery program, NextGenEU. This initiative involves debt pooling and new crisis-fighting tools introduced by the ECB to provide stimulus and stabilize bond markets. Despite recent improvements, deep structural challenges remain, including aging populations, overregulation, climate change, and global fragmentation. Contrary tot he movies, the “cut” indicating the end of an action needs to be seen as the beginning of more corageous action instead.

For more than two decades, the US has been in a growth phase that, compared to both Europe and China, is not only more stable but also steeper. This is due to the increase in productivity in the US. It is currently believed that AI could provide an additional boost to this growth. Whether this boost will come from American companies or their applications remains to be seen. What is clear, however, is that Europe must quickly reorient itself to keep its national debt manageable.

Debt and debt evolution are two determining factors in their sustainability. Unlike the single currency, the Eurozone does not (yet) have centralized debt issuance. As a result, financial markets can occasionally create stress moments, such as with Greece in 2011. To increase credibility, a revision of the Maastricht criteria is clearly necessary.