Recent inflation data has strengthened the resolve of conservative European Central Bank (ECB) officials to resist immediate pressure to reduce interest rates at this week’s meeting. A short while ago, investors were optimistic that the ECB might lower lending expenses this month, spurred by the quick descent of eurozone inflation from topping 10% down to less than 3%.
However, such forecasts have waned lately, after ECB officials communicated their hesitation to ease monetary strategy, despite speedy consumer price reductions and ongoing stagnation in the eurozone economy. Data on inflation from the single-currency union released last Friday, which exposed a drop less than expected from 2.8% in January to 2.6% in February, only stiffened the stand of the ECB’s more hard-line officials to fend off calls for interest rate cuts.
Robert Holzmann, the more conservative head of Austria’s central bank declared on Friday: “After observing European and country-level inflation data, it seems clear that we must remain vigilant and not rush decisions.” Even more moderate officials appear to have come to terms with a cautious stance on slicing lending rates, emphasised by a statement last week from Yannis Stournaras, Governor of the Greek central bank, that a change should be on the cards “no later than June”.
Analysts identified the persistent climb of service sector inflation as the chief reason for officials being wary about prematurely slicing rates. Prices in the Eurozone service industry rose by 3.9% in February, a negligible reduction from successive 4% increases over the last three months.
This unchanging service sector inflation figure “will strengthen the resolve of the many governing council members advocating for a measured approach, making a rate cut before June quite improbable”, posited Marco Valli, chief European economist at the Italian UniCredit bank.
Tomasz Wieladek, an economist at the investment firm T Rowe Price, characterized the month-on-month rise in Eurozone inflation to 0.6% in February, the quickest since the previous April, as a “very concerning development”.
Analysts from leading institutions such as Barclays and Goldman Sachs have shifted their predicted timeline for the initiation of rate cuts by the European Central Bank (ECB) from April to June, according to the data from the previous week. Increasingly aggressive stances from the U.S. Federal Reserve and more intense than anticipated U.S. inflation data could encourage ECB rate setters to adopt a more measured approach toward rate reductions.
Martin Wolburg, an economist from Italy’s Generali Investments, suggests that the increased hawkish behaviour by the U.S. Federal Reserve heightens the ECB’s need to avoid prematurely underestimating inflation.
It is anticipated that this week, ECB policymakers will voice their concern that the swift growth of wages may cause a rapid surge in prices within the labour-intensive services sector, significantly impacting inflation calculations. Collectively bargained wages, which cover the majority of the Eurozone workforce, have dipped from a record 4.7% growth in the third quarter to 4.5% in the last quarter of the prior year. However, this is still substantially above the 3% growth necessary to meet the inflation target of 2%, according to the ECB.
The persistent stability of the labour market, demonstrated by a record low 6.4% unemployment rate in January, is a central aspect of the ECB’s decision to cautiously ease its monetary policy following a record 4% raise in its primary policy rate in the preceding year.
Katharine Neiss, chief European economist at PGIM Fixed Income, suggests that the continuous strength of the labour market remains key. Any indication of rapid deterioration, significant unemployment increases, or insolvency risks, would compel the ECB to not only cut rates early but also to do so drastically.
However, some European politicians are advocating for the ECB to take more action to support the struggling Eurozone economy, which experienced no growth in the fourth quarter, following a period of stagnation for most of the previous year. Both the Italian and Portuguese finance ministers requested a quick reduction in borrowing costs at the G20 meetings in São Paulo last week. Meanwhile, the ECB has maintained the interest rates at the record high of 4%.
The Central Bank is anticipated to reduce its growth and inflation predictions during its upcoming Thursday meeting while maintaining steady rates. These potential developments could spark concerns in certain sectors about excessive economic suppression to control price movements, specifically in light of January’s drop in euro zone bank loans to businesses and households.
Fixed income research analyst at MFS Investment Management, Annalisa Piazza, suggested that conditions currently favour a rate cut. However, she predicts that the ECB will continue to emphasise the need for additional wage data, a step she believes to be unnecessary.
Meanwhile, the economic fragility across much of Europe – especially in Germany- has not eclipsed signs of an emerging revival in activity. These hopeful indicators, which some assertive ECB authorities may take as additional evidence against hasty relaxation of monetary policy, feature enhanced GDP estimates for France and Italy’s Q4. This hints at an upward adjustment of the comprehensive euro zone growth data into optimistic territory.
Following criticism for sluggishness in raising rates in response to the largest inflation increase witnessed in decades in 2022, it appears the ECB is now set on a cautious path to relaxing policy in order to dodge further reproach.
Carsten Brzeski, an economist at the Dutch bank ING, noted that previous underestimations of inflation may encourage the ECB to adopt a more restrictive bias in future policy alterations. – Financial Times Limited 2024
Remain up-to-date with business updates sent directly to your phone, follow The Irish Times on WhatsApp, and catch the latest Inside Business podcast published weekly.