As widely forecast and well-flagged by the central bank itself, the ECB today announced the first reduction in interest rates since September 2019. All the three main rates were cut by 25 basis points putting the refi rate at 4.25 percent, the (still key) deposit rate at 3.75 percent and the rate on the marginal lending facility at 4.50 percent.The decision was almost unanimous with just one governor not in favour.

The previous forward guidance was also amended and now states that the bank will"keep policy rates sufficiently restrictive for as long as necessary…" to achieve the inflation target. In other words, the bank is providing no useful signal about when it might ease again but the wording suggests that it is in no hurry. It remains data-dependent so it is safe to assume that the focus will remain on the HICP reports in general and core and service sector inflation in particular. However, after the surprisingly firm April release and strong first quarter wage growth, the likelihood is that the ECB will want to be all the more confident that it can meet the 2 percent target on a sustainable basis. As such, another move before the next round of economic forecasts in September would seem unlikely.

With regard to non-standard policy measures, the bank confirmed that falling interest rates will not impact its efforts to shrink its balance sheet. Rather, as previously stated, from next month, QT will be expanded to include sales from the pandemic emergency purchase programme (PEPP) with an average monthly target for disposals of €7.5 billion through December.

Today's updated economic projections show only relatively minor revisions to the March outlook but, of note, include higher headline and core inflation rates this year and in 2025. However, crucially, at the end of the projection horizon, the overall rate is still seen at 1.9 percent and the core at 2.0 percent. In terms of the real economy, GDP growth is expected to be a little firmer this year (0.9 percent) but marginally weaker next (1.4 percent) and unchanged in 2026 (1.6 percent). In other words, growth is expected to recover only slowly and remain quite sluggish over the medium-term.

Having so clearly telegraphed its actions, the ECB had boxed itself in to the extent that no ease today would have gone down in financial markets like a lead balloon and seriously compromised the bank's credibility. As it is, with the first cut now safely out of the way, investors are left contemplating how quickly official interest rates can be lowered again and where the floor to the easing cycle might lie. A July cut appears improbable so, assuming that a 1 percent real rate might be appropriate longer term, reaching the implied 3 percent nominal floor will not happen quickly.

The ECB is widely expected to cut its key interest rates by 25 basis points putting the refi rate at 4.25 percent and the deposit rate at 3.75 percent.

The European Central Bank (ECB) sets monetary policy for all members of the Eurozone. The highest decision-making body is the Governing Council which comprises the six members of the Executive Board and the 20 presidents of member central banks. Policy meetings take place roughly every six weeks but, due to the sheer number of participants, a rotation system has been introduced so that the total number of votes is capped at twenty-one. The benchmark interest rate is the rate on the main refinancing operations (refi rate) which sits between the marginal lending facility rate and deposit rate. The ECB's primary objective is price stability which since July 2021 is based upon a symmetric 2 percent target for the annual inflation rate.

The European Central Bank determines interest rate policy at their Governing Council meetings. The Council is composed of the six members of the Executive Council and 17 presidents of member central banks (Bank of France, Bundesbank, etc). The Governing Council meets now meets every six weeks. The European Central Bank had an established inflation ceiling of just less than 2 percent which was modified in July 2021 to 2 percent. The ECB's measure of inflation is the harmonized index of consumer prices (HICP). Each member of the Governing Council has one vote and decisions are reached by simple majority. In the event of a tie, the President has the casting vote. Only short-form minutes are released so how individual members voted is not known.

As in the United States, European market participants speculate about the possibility of an interest rate change at these meetings. If the outcome is different from expectations, the impact on European markets can be dramatic and far-reaching. The rate set by the ECB serves as a benchmark for all other interest rates in the Eurozone.

The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the stock market, while lower interest rates are bullish.