ECB holds rates at record highs, signals upcoming cut

The European Central Bank held borrowing costs at a record high as expected on Thursday but signalled it may soon cut interest rates, even as investors increasingly questioned whether its U.S. counterpart will follow along.

The ECB has kept interest rates steady since September but has long signalled that cuts were coming into view, with policymakers awaiting a few more comforting wage indicators to accompany benign inflation figures before pulling the trigger.

"If the Governing Council's updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission were to further increase its confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction," the ECB said.

The ECB said that incoming information has broadly confirmed its previous inflation assessment while wage growth was moderating and firms were absorbing more of the labour cost increases via their profit margins.

Nevertheless, domestic price pressures are strong and are keeping services price inflation high, the ECB said in a statement.

The biggest complication could be if the U.S. Federal Reserve delays its own policy easing after hotter-than-forecast inflation data. The world's biggest central bank generally sets the tone for global financial markets.

But even that would only slow and not stop the ECB, given a widening gap in performance between the U.S. economy and that of the 20-country euro zone, economists said.

The currency bloc is now in its sixth straight quarter of economic stagnation and the labour market is starting to soften. The U.S. economy, on the other hand, continues to grow above trend, its labour market remains tight and inflation rose more than expected last month, raising the risk of price growth getting stuck.

ECB policymakers have long pointed to a June rate cut, a de facto pre-commitment according to financial markets, and walking back from that would damage the central bank's credibility.

But ECB President Christine Lagarde, due to speak at a 1245 GMT news conference, is likely to avoid any talk of what happens beyond June, especially as there is little consensus yet on how far and fast interest rates need to fall.

Markets have priced in 75 basis points of cuts this year, or two moves beyond June, which could come in September and December, when the ECB also publishes new economic and inflation projections.

Supporting the case for rate cuts, consumer price inflation fell to 2.4% last month and could ease back to the ECB's 2% target before year-end, well ahead of the bank's own 2025 projection.

Meanwhile rapid wage growth, seen by the ECB as the single biggest inflation threat, is slowing, labour markets are softening, investment is weak and bank lending stagnant - all pointing to a further decline in price pressures.

This outlook is in stark contrast to the United States, where rate cuts have been priced out in recent weeks given robust labour market data and stubborn price pressures.

Markets now see just 40 basis points of Fed easing this year and the first move is not fully priced in until November, two days after the U.S. election.

The ECB insists that it sets policy independently, but prolonged divergence with the Fed could be counterproductive.

Faster ECB rate cuts would weaken the euro and push up yields as funds flow across the Atlantic, so markets would simply undo some of the ECB's work.

A June rate cut would pre-empt the Fed in any case, but the ECB will be careful not to get too far ahead in subsequent meetings, economists argue.