ECB eyes summer pause on bumpy road to disinflation

Clouds hang over the European Central Bank (ECB) building on September 14, 2023 ahead of the meeting of the governing council of the ECB in Frankfurt am Main, western Germany. (Photo by Kirill KUDRYAVTSEV / AFP)

Frankfurt, Germany — European Central Bank policymakers are expected to leave borrowing costs on hold Thursday, buying time to make sure inflation is on the right track before cutting interest rates again.

The ECB’s governing council reduced interest rates for the first time in five years at last month’s meeting, following an aggressive cycle of monetary tightening to tame red-hot inflation.

The June cut lowered the key deposit rate from a record four percent to 3.75 percent, bringing some relief to households and businesses.

READ: ECB to opt for summer pause after initial rate cut

But ECB president Christine Lagarde warned in Portugal’s Sintra this month that rate-setters would need time to “gather sufficient data” before deciding their next move.

“The ECB will almost certainly leave its monetary policy unchanged,” said Unicredit economist Marco Valli.

Instead, observers will be listening closely to Lagarde’s afternoon press conference for hints of a rate cut in September, when the ECB will be armed with fresh growth and inflation forecasts.

Eurozone inflation has steadily fallen from a 10.6-percent official peak in 2022 after Russia’s war in Ukraine and pandemic-related supply issues sent prices surging.

READ: ECB diverges from Fed on rates, sparking jitters

Inflation eased to 2.5 percent in June, following a surprise uptick in May.

While still above the ECB’s two-percent target, inflation is “heading in the right direction”, Lagarde said in Sintra.

But it was “likely to be a bumpy road until the end of 2024”, she warned.

Wages, services in focus

According to quarterly forecasts unveiled in June, the ECB now expects inflation to return to target in late 2025.

But policymakers still see several risk factors on the path to disinflation.

“The ECB is right not to declare victory,” said Capital Economics economist Jack Allen-Reynolds.

Core inflation, which strips out volatile food and energy prices, remained stubbornly high at 2.9 percent in June.

Inflation in the services sector was sticky at 4.1 percent, and is increasingly becoming a headache for ECB officials.

They are also keeping a close eye on wage growth, as workers in the 20-nation currency club push for salary hikes to compensate for higher living costs.

“Stickiness in services prices, fast wage growth and a resilient labour market argue against back-to-back rate reductions,” said Unicredit’s Valli.

Waiting for September

The eurozone economy meanwhile emerged from recession with greater-than-expected growth of 0.3 percent in the first quarter of 2024.

But recent data suggested the economic recovery “has lost steam” in the second quarter, said ING bank economist Carsten Brzeski.

Many observers believe the ECB’s next rate cut will come at the September meeting, when policymakers will have updated information about the progress on inflation and the strength of the economy.

One further rate cut before the end of year is also considered likely, possibly in December, analysts say.

“Investors will look for hints on potential moves in September and afterwards,” Valli said about Lagarde’s press conference.

But Lagarde “will probably stick to her data-dependency mantra and offer no further guidance,” he added.

September is also when the US Federal Reserve is increasingly expected to begin cutting rates, with confidence growing that US inflation is coming down to target.

Lagarde, a former French finance minister, can also expect to be grilled Thursday about political uncertainty in her home country after snap elections produced a hung parliament.

French central bank chief Francois Villeroy de Galhau last week called for reducing the country’s large deficit, amid concerns that increased government spending could push up inflation.

“We expect president Lagarde to be guarded in her responses to direct questions on France,” Deutsche Bank economists said in a note.

She is likely to say “that the ECB is attentive to what is happening” and reiterate “that euro area member states have agreed a fiscal framework with which they are expected to comply”, they added.