The ECB’s leap ahead of the Federal Reserve

The ECB cut its main policy rate by 0.25 percentage points, to 3.75%. This is the first time in the central bank’s 20-plus-year history that it has reduced the policy rate without a crisis unfolding in the background. Rather than firefighting, Ms. Lagarde this time is estimating, based on the ECB’s internal economic models, that inflation will continue to decelerate.

The argument to start cutting rates now is that, as disinflation allegedly unfolds, monetary policy risks becoming tighter than intended because real interest rates rise as inflation slows. ECB officials speak of the risk that inflation could fall below target if they don’t ease now—code for a fear their policies could hurt growth.

Is this really what’s happening in the eurozone? It’s not obvious inflation is on a glidepath back to the ECB’s 2% target. Headline consumer-price inflation was 2.6% year-on-year in May, up from 2.4% in each of the previous two months, and 2.8% in all-important Germany. So-called core inflation excluding food and energy was 2.9% year-on-year in the eurozone in May, and 3.5% in Germany.

The models that reassure the ECB rely on assumptions about inflation’s causes (and especially the role of expectations) that have been unreliable in recent years. Ms. Lagarde is taking a risk that Federal Reserve Chairman Jerome Powell is resisting. He has said he won’t cut U.S. rates until he sees concrete evidence the Fed is achieving its inflation target.

Meanwhile, recent data suggest that eurozone economic growth is holding up reasonably well despite, or perhaps because of, higher real interest rates. Eurozone GDP grew 0.3% quarter-on-quarter in the first three months of this year, breaking a two-quarter contraction. Europe faces an economic-growth problem but it’s not one the ECB can solve. Instead scrap the green-energy policies strangling German manufacturers, the Italian bankruptcy laws protecting low-productivity firms, and the French tax rates that suffocate entrepreneurship.

The biggest risk for the ECB concerns the exchange rate. Exchange volatility is driven by divergence between the Fed and other central banks, and Ms. Lagarde is making a euro depreciation more likely. The euro started dipping relative to the dollar as ECB officials signaled in recent weeks that Thursday’s rate cut was all but certain—and the euro lost 0.31% of its value against the greenback in the two days before Thursday’s meeting.

The euro gained immediately after Ms. Lagarde’s announcement, perhaps because investors hope eurozone growth will continue and assume the Fed will cut rates later this year. But expect more depreciation if European growth disappoints as it often does, and if it becomes clear Mr. Powell isn’t wavering.

Exchange-rate volatility has consequences. Those include disruptions to investment flows, higher import-price inflation especially for energy, and the risk of a new trade war if a second Trump Administration seizes on the excuse to impose tariffs. One modest rate cut is hardly a radical shift, but easier money isn’t a free lunch.