FRANKFURT: The European Central Bank kept interest rates unchanged at a record-high 4% as expected on Thursday and reaffirmed its commitment to fighting inflation, giving no hint that policymakers are even contemplating policy easing.
The ECB ended its fastest ever rate-hiking cycle in September but has been adamant that discussing a reversal would be premature, since price pressures have not been fully extinguished and many wage negotiations have yet to conclude.
Investors, however, are betting that the ECB is getting it wrong on both growth and inflation and will be forced to make an about-face, delivering five rate cuts in rapid succession from early in the spring.
European shares dip amid caution ahead of ECB policy decision
But the ECB did not signal such a pivot on Thursday and made only nuanced changes to its statement, repeating its longstanding guidance that holding interest rates at the current level for sufficiently long will bring inflation back to target.
“The consensus around the table was that it was premature to discuss rate cuts,” ECB President Christine Lagarde told her regular news conference following the decision, reiterating that future decisions would depend on incoming data.
“We need to be further along the disinflation process to be confident that inflation will be at target - sustainably so.”
The bank said in its written statement that inflation trends “broadly” confirmed its previous assessment, but removed a reference in previous statements to elevated domestic price pressures and strong labour cost growth.
Lagarde said growth risks were tilted to the downside and included the restrictive effect of monetary policy, wars in Ukraine and the Middle East and a global economic downturn.
Disruptions to trade from attacks by Yemen’s Houthi group on shipping in the Red Sea could add to inflation by pushing up energy and freight costs, she warned.
“We are observing it very carefully,” Lagarde said.
She declined to comment on speculation that a first rate cut could come at the ECB’s June meeting.
Lagarde and ECB chief economist Philip Lane have recently pointed to first-quarter wage settlements, for which figures become available in May, as a relevant gauge, which some have seen as a clue to the timing of a move.
She pointed to signs that demand for labour was easing and evidence that moderating wage growth was “directionally good from our perspective”.
The ECB’s pushback on early rate cuts has had some impact on markets but investors still see 125 basis points of reductions this year, or five moves, with the first in April or June.
RECESSION
The big discrepancy in expectations largely stems from a different outlook on growth and just how much past rate hikes are slowing economic activity across the 20 countries that use the euro currency.
The ECB expects household and government spending to drive a recovery but data appear to be painting a bleaker picture, with manufacturing remaining in recession and services cooling. Earlier on Thursday, Germany’s closely watched Ifo survey pointed to worsening business sentiment.
The euro zone was probably in recession last quarter and got off to a slow start in January, making the current quarter the sixth in a row with broadly flat or negative growth. A long-predicted recovery meanwhile keeps getting pushed further out.
A weak economy, along with muted commodity prices and high interest rates, will keep stifling inflation, which stood at 2.9% in December and is not currently expected by the ECB to fall back to its 2% target until 2025.
Many disagree with that projection.
“We continue to expect headline and core HICP inflation rates to fall to 2% already before the middle of this year, a year or more earlier than the ECB forecasts,” Deutsche Bank economists said.
Lower inflation would mean rising real interest rates, effectively tightening policy in a recessionary environment. “This would raise the risk of an outright recession and a genuine shock to the labour market,” Deutsche Bank added.
Some think that the ECB’s insistence that even more evidence of disinflation is needed for it to act raises the chance of a policy error.
“Having overlooked the negative impact of monetary tightening on growth until now, the ECB remains biased towards cutting too little, too late,” TS Lombard’s Davide Oneglia said.