Despite Falling Inflation, ECB Should Hold Interest Rates on Thursday

Decision by the European Central Bank to cut interest rate cuts likely pushed back until June

Antje Schiffler 5 March, 2024 | 8:31AM
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European Central Bank

Even with inflation falling faster than expected, the European Central Bank is expected to keep interest rates unchanged at this week’s policy meeting, analysts say.

While the next move from the ECB is likely to be lowering interest rates, any interest rate cut is now expected to come in June. In addition, expectations are growing that while interest rate cuts are on their way, the ECB will be lowering rates by a smaller amount in 2024 than had been previously forecast.

For investors, with the ECB seen holding rates this week, instead the focus will be on any clues to the timing of that interest rate cut coming from the ECB’s updated inflation and macroeconomic outlook.

ECB Holding Interest Rates at Record Highs

Since September 2023, the ECB has kept its key interest rate – known as the main refinancing operations rate or MRO - at a record high of 4.5%.

In its first meeting of the year on January 25, the ECB’s governing council decided to maintain its policy stance, and did not give any hint of when rate cuts will happen. But inflation numbers have fallen since that meeting and the expectations are rising that the ECB will be cutting interest rates. 

“Two thirds of economists are now predicting an interest rate cut in June according to a recent Reuters poll. This is despite the ECB commenting at every available opportunity about the danger of resurgent inflation”, said Michael Field, European market strategist at Morningstar.

“The fact of matter is though that inflation has fallen considerably and the trajectory is still positive. The MRO stands at 4.5%, meaning the bank has a lot of room for manoeuvre. It can implement a small cut in June, and wait to see the effects, without upsetting the applecart.” 

“With the European economy teetering on recession, we believe the ECB must now balance the (outside) risk of resurgent inflation, with the potentially more pressing need to ensure the economy doesn't enter a prolonged recession. June seems like a reasonable compromise in this regard.”

‘No Reason to Rush’ on Interest Rate Cut Decision

Key ECB members have suggested that any decision to lower interest rates is months away.

ECB council member Peter Kazimir last week confirmed that expectation. "There is no reason to rush a rate cut," Slovakia’s central bank chief told Reuters. "June would be my preferred date, April would surprise me and March is a no go."

ECB board member Isabel Schnabel told the Financial Times in early February that inflation “could flare up again”. The “last mile” of getting inflation down will be the hardest, she said. "We see sticky services inflation. We see a resilient labour market. At the same time we see a notable loosening of financial conditions,” she said.  

But comments by Italy's central bank chief Fabio Panetta show some division on the council. In a separate interview, he told the newspaper that the time for cutting rates is “fast approaching”. Striking more doveish tones than Schnabel, he dismissed fears of a fresh inflation spiral and said inflation in the euro area was falling faster than expected. 

Watch To Watch at the ECB Meeting

With the ECB expected to announce rates are being held steady when it unveils its decision on Thursday, the focus for investors will be on the ECB’s economic outlook.

The ECB publishes its projections on economic growth, inflation, wages, unemployment and trade Thursday for the first time this year, with three more updates to follow on a quarterly basis throughout 2024.

Economists at Deka Bank expect that the ECB’s projections will show slightly lower inflation this year and continued convergence towards the 2% target towards the middle of next year. The press conference is also likely to address the extent to which the slightly lower rise in wages mitigates upside risks to the inflation outlook.

ECB president Christine Lagarde has repeatedly stressed that the disinflation process would have to advance further for the central bank to be sure that it is sustainable.

Inflation Falling Toward ECB Target

Inflation in the eurozone is clearly falling quicker than the ECB had projected, Kazimir added.

The consumer price index was down by 2.6% in February, from 2.8% in January. But core inflation remained at 3.1% (January: 3.3%) and service inflation hovered around 4%.

"Disinflation is going much quicker than we expected on the headline level but we can’t be certain yet about core inflation because wage developments remain unclear," Kazimir told Reuters. "For that, the outcome of collective bargaining deals will be crucial. All in all, we are on the right track but we’re not yet there."

Eurozone Inflation for February Falls

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Antje Schiffler  is an editor for Morningstar in Frankfurt.

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