ECB rate cut: A first step, not a new dawn

The ECB’s rate cut this week was well telegraphed and widely expected. This does not make it any less important. It’s a first step in the right direction more than a paradigm shift, particularly for the real estate sector.

Across the world of central banking, this wasn’t the first rate cut. The Swiss National Bank moved in March and CEE banks were already acting in the final quarter of last year. However, the ECB’s decision marks the first downward move by one of the majors.

Concerns have been raised that with the ECB cutting its policy rate in June, it would become misaligned with the U.S. Federal Reserve and this could have negative economic effects, such as causing the currency to depreciate.

However, greater concern would stem from the ECB ignoring the conditions of the eurozone economy - which are quite different from those in the U.S.

It’s clear that tighter monetary policy has done its job in Europe: new borrowing fell sharply, debt servicing costs increased, savings rates went up, and economic activity that drove inflationary pressures slowed. In the U.S., the effects of tighter rates have been muted at best, thanks to offsetting fiscal stimulus, long-term fixed borrowing such as mortgages, and corporate borrowers locking in low rates before the tightening cycle began.

In short, monetary policy was contractionary in Europe and needed to be loosened as inflation fell. The story is not the same elsewhere.

So what next? It’s likely the ECB will wait and see what effects its policy change has and whether inflation has been beaten. The bank has a chequered history of moving at the wrong time – raising rates too early after the global financial crisis and too late when inflation soared – so it will likely act cautiously.

The market view prior to this week’s cut was over 50% probability for another move before year-end, and further cuts in 2025. Scrutiny over every data release has been intense this year as markets scoured the tea leaves for omens of central bank policy intentions, and while forecasts will change, this behaviour won’t.

It’s important not to get carried away: this is not a new dawn.

Policy rates remain well into contractionary territory and have further to fall before having any stimulative effect on economic activity more generally, let alone on real estate. But it’s a step in the right direction. It opens the door for both further cuts in the future and to a future compression in real estate yields, an attractive prospect for investors. Lower future borrowing costs and the possibility of capital value appreciation will likely begin to improve both underwriting ability and willingness, while increasing transactional liquidity. But this will happen slowly, and at different speeds. Market adjustment was not uniform as yields rose, and it will not be as they compress. We anticipate that more liquid gateway markets will adjust more quickly.