On 6 June the European Central Bank (ECB) reduced interest rates for the first time since 2019, delivering what had been practically unanimously expected in the markets. The ECB had prepared the way for the downward shift in rates, with clear signals from ECB officials that a rate cut would occur in June. Anything else, such as maintaining the status quo, would have been unimaginable, with a rate hike likely leading to a communications disaster.

Following the lead of the central banks of Canada, Sweden, and Switzerland, the ECB has now entered into a mode of interest rate cuts – ahead of even the US Federal Reserve. This move sends a clear signal to market participants. Of course, central bankers always keep all options open and do not categorically commit to a predetermined interest rate path for a set period. They cannot afford to do so, as it would practically relinquish their ability to act, and undermine their credibility, while potentially tying their hands in terms of reacting or adapting to changing market conditions and economic realities. But what comes next in terms of interest rate policy after this signal, and what are the most likely scenarios?

First scenario. If there is no upward surge in inflation, and no escalation in geopolitical hotspots, it is expected that ECB President Christine Lagarde will move relatively quickly to reinforce the message now conveyed to the markets. As a result, a second interest rate cut could occur as early as July. This would keep the interest rate speculation alive in the stock markets, with indices like the DAX continuing to be well-supported. Consequently, there would likely be no significant increase in Bund yields – quite the opposite. Additionally, the euro is expected to be on the weaker side due to interest rate dynamics.

Second scenario. The ECB assesses the effects of the current interest rate cut and verbally keeps interest rate speculation alive in the markets. This can be done by repeatedly hinting in the coming weeks that the next move will not be upward, only waiting a little longer to have enough indications that inflation is moving further towards the ECB's target of around 2%, and that the ECB can thus be confident of sustainable success in fighting inflation. And seriously, does anyone in the markets really expect to see inflation rates of 10% again? In this case, the second interest rate cut downward would not be on the agenda for July, but would rather occur after the summer break, meaning in September.

This would give the ECB enough time to wait for the new macroeconomic data. In September, the ECB will also present its next projections for inflation and growth. If these point in the right direction, Lagarde could well move with an interest rate cut. In this scenario too, stocks are expected to be well-supported throughout the summer, Bund yields are likely to be on the lower side, and the euro is not expected to strengthen significantly. All that's left is to assign a probability to both scenarios. It looks about fifty-fifty, and more data will show which way things are moving in June. This leaves markets and analysts enough room for interest rate speculation and adjustments in the coming weeks.

And what could upset both scenarios? Inflation. And if you look at commodity price trends, which have uniformly increased, inflation could indeed rise – but certainly not towards 10%. The second ECB interest rate cut could then be pushed back to December.