European Central Bank unlikely to cut interest rates as economy stalls

07 March 2024 , 09:35

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President of European Central Bank, Christine Lagarde, is unlikely to favour interest rate cuts until the central bank sees more evidence that inflationary pressures are abating (Image: Copyright 2024 The Associated Press. All rights reserved)

Europe's inflation has dropped significantly, but hopes for a quick interest rate cut have vanished.

The energy crisis in Europe, caused by Russia's war in Ukraine, has eased up. Inflation has fallen from its painful double-digit peak. However, it's unlikely that the European Central Bank (ECB) will cut interest rates at their meeting on Thursday, even though higher borrowing costs are slowing down the economy.

The wait for a rate cut could be longer than many initially thought. Christine Lagarde, the President of the ECB, is expected to stress that the bank wants solid proof that inflation will continue to decrease towards their target of 2%. This is what analysts who monitor the bank believe, and financial markets seem to agree. While they had previously predicted a rate cut as early as April, those predictions have now faded.

Markets are now expecting a quarter-point cut in June. In Europe, inflation was down to 2.6% in February, a significant drop from its peak of 10.6% in October 2022. However, the consumer price index has been stuck between 2% and 3% for five months, causing worries that reaching the ECB's goal may take longer than hoped.

While the spikes in food and energy prices that helped drive the outbreak of inflation have eased, inflation has spread to services, a broad sector of the economy that includes everything from movie tickets and office cleaning to tuition and medical care.

Shop prices 'are yet to peak and will remain high' as inflation hits new heights

Meanwhile, wages rose as workers started bargaining for higher pay to makeup for lost purchasing power as inflation ballooned. Prices for natural gas - which is used to power factories, heat homes and generate electricty - have fallen to around 24 euros ($26) per megawatt hour, not much higher than levels seen before Russia started threatening Ukraine.

And oil prices have been flat as Saudi Arabia and other members of the OPEC+ coalition of oil producers maintain cuts to output that have only put a floor under prices.

"Given that most officials seem to be coalescing around a start to the easing cycle in June, the (ECB) governing council is likely content with current market pricing," wrote analysts at ABN AMRO Financial Markets Research. "Therefore, the aim of communication following the end of the meeting will likely try to not rock the boat one way or the other."

Lagarde's message will likely be that "the central bank wants to see more evidence that domestic inflationary pressures are abating," the analysts said in a note. The ECB has raised its key rate from minus 0.5% to a record-high 4% in just over a year, starting in July 2022. But high rates can weigh on economic growth, too.

Pressure for a rate cut is coming as the economy has stalled. The 20 countries that use the euro currency saw no growth in the fourth quarter of last year after shrinking 0.1% in the previous quarter. Germany, Europe's largest economy, expects to grow just 0.2% this year.

Complicating matters is the fact that it's not a classic downturn because unemployment remains low. Markets will watch closely for signals on when the first rate cut will come. Carsten Brzeski, chief of global macro at ING bank, said: "We still think that the ECB has good reasons to resist that pressure and to push back expectations." Lagarde's comments at her post-meeting news conference will likely be "sending more precise signals for a June rate cut," he said.

Lawrence Matheson