When Will the European Central Bank Finally Cut Interest Rates?

FRANKFURT — As inflation cools but remains stubbornly high across the eurozone, all eyes are on the European Central Bank and the trillion-euro question: When will policymakers finally relent and start cutting interest rates?

The ECB’s next meeting this Thursday offers perhaps the biggest clue yet about the timing of an eventual rate cut, as new economic projections and forward guidance are unveiled. But conflicting data signals and divergent views within the rate-setting Governing Council suggest any clarity may still be elusive.

For months, investors were convinced a rate cut was imminent, potentially as soon as this week’s March 16th meeting. But those expectations have faded amid persistent underlying inflation pressures and a modest economic rebound. Many analysts now see the first cut delayed until June at the earliest.

“The ECB will likely take a cautious approach – as it would not want to undo its progress in the fight against inflation on the home stretch towards the target,” said Holger Schmieding, chief economist at Berenberg. “We thus expect the ECB to wait until June for a first rate cut of 25 basis points.”

The great rate cut debate underscores just how challenging the ECB’s mission has become after a year of record-breaking interest rate increases aimed at slaying a decades-high surge in consumer prices. While headline inflation has cooled to 2.6% thanks largely to easing energy costs, underlying price pressures have proven more obdurate.

Services inflation, for instance, accelerated again last month to 3.9%, while headline “core” inflation excluding food and energy held steady at 5.6%. Alarmingly for the ECB, wages across the eurozone continue to rise rapidly as workers demand higher pay to keep pace with the increased cost of living.

Recent strikes by transport workers in Germany and other labor actions reflect how ingrained elevated inflation expectations have become in the real economy. Such factors make central bankers nervous about pivoting too quickly away from policy tightening.

“The upside core surprise was in services, which the ECB will interpret as more domestic and therefore more cautionary for monetary policy,” said Mark Wall of Deutsche Bank. “There is no reason to think that the short-term pace of underlying inflation has eased. If anything, it might be a little stronger.”

At the same time, Europe’s economy has displayed remarkable resilience of late, potentially allowing the ECB to leave restrictive policies in place for longer.

Surveys of purchasing managers showed business activity stabilizing in February, with the services sector even returning to growth territory as consumers continued spending despite high inflation. Unemployment remains at historic lows across the 20 countries using the euro currency.

Such better-than-feared economic data has eased pressure for urgent rate cuts, since tighter monetary policy is designed to cool excess demand and bring inflation back toward the ECB’s 2% target.

“Unlike in previous meetings, the question of the timing of a rate cut will now be on the agenda,” said Dirk Schumacher of Natixis. “But the updated staff projections are likely to show a downward revision of inflation for this year, reinforcing the signal that the ECB is moving closer to a rate cut.”

Whichever path ECB President Christine Lagarde and her colleagues choose in the coming months, their actions will have far-reaching consequences.

Cut rates prematurely and resurgent inflation could become entrenched, requiring even higher borrowing costs down the road. But keep hiking or hold steady for too long amid a fragile recovery, and the ECB risks unnecessarily depressing growth and employment.

Walking that tightrope is perhaps the greatest challenge facing any central banker. And given the momentous decisions ahead, Lagarde’s performance during Thursday’s press conference questioning will be must-see viewing for investors, economists and governments alike desperate for clarity.

No matter what the ECB signals this week, the great rates debate seems unlikely to conclude anytime soon. Unrelentingly high inflation has become the era’s biggest economic challenge – one where the correct policy response remains fiendishly difficult to discern.

You May Also Like

Related Posts

x
x