If what goes up must come down, the pressing question on the minds of many in Europe is when will interest rates start to fall? In recent months, interest rates have been set at the highest ever recorded by the European Central Bank.
Investors expect the central bank to cut interest rates soon, perhaps in April. Traders say interest rates should be lower because inflation has slowed significantly (it has been below 3% since October) and the local economy is weak. Financial market trading suggests the central bank will cut interest rates by more than 1 percentage point, or five to six quarter points, by the end of the year.
But policymakers are trying to steer market opinion in a different direction and delay expectations for rate cuts. Many on the central bank's board are wary of declaring victory for inflation too soon to avoid inflation stabilizing above the central bank's 2% target.
The European Central Bank stuck to this outlook on Thursday. Interest rates were kept unchanged, and deposit interest rates were kept at 4% since September.
Bank Governor Christine Lagarde said on Thursday that interest rates were at a level that would make a significant contribution to bringing inflation back to 2% “in a timely manner” “if maintained long enough.”
He added that the region's deflation process needs to make “further progress” for the central bank to be confident that inflation will remain on target.
Not now, but maybe in the summer
Recently, changes have been occurring in central banks. Lagarde said in December that interest rate cuts were not on the table and stressed the need to be wary of inflation. However, with the arrival of the new year, the atmosphere changed a little. And last week, Lagarde said in an interview with Bloomberg News that interest rates were likely to be lowered in the summer.
Asked again about this at a press conference in Frankfurt on Thursday, Lagarde said the 26-member board still agreed that it was “too early to discuss rate cuts.” He said policymakers would make decisions based on upcoming economic data rather than following a calendar, a move that appeared to be aimed at discouraging bets on rate cuts.
Still, she said, “I usually stand by my comments.”
Traders have taken note of this comment and are now holding high hopes for a rate cut at the central bank's June meeting, while expectations are rising for April.
What investors think matters, so central banks need to choose their words carefully to guide markets. If traders start expecting interest rates to fall, they could move markets in that direction and ease financial conditions sooner than central banks would like. That could undermine efforts to rein in the economy and curb inflation. This began to happen in earnest late last year after the Federal Reserve signaled that it would cut interest rates this year, which triggered market movements within the United States and internationally.
delay in expectations
Policymakers are trying to postpone hopes for a rate cut until at least the summer, arguing that the necessary data, particularly on wage growth, won't be available until the June meeting.
“The ECB will err on the cautious side,” said Oliver Rakau, Germany's chief economist at Oxford Economics, saying the ECB would err again on inflation after previously underestimating its strength. It's because he's nervous about committing a crime.
On the other hand, those who argue that inflation will continue to slow are trusting that the economy cannot withstand any larger shocks. Attacks on commercial ships in the Red Sea have caused shipping prices to soar, with analysts warning that inflation could reignite if the disruption is prolonged and the higher costs are passed on to consumers. There is.
Immediately?
Meanwhile, data shows inflation is easing faster than central banks expected. Economists at Berenberg Bank said headline inflation rose in December but could fall below 2% by the fall as some government support measures ended.
The region's economy is also sluggish, not overheating. Germany's economy, the region's largest, is in a slump, data showed it contracted by 0.3% last year. Separate data released this week showed that demand for loans from businesses and households across the euro area continued to decline.
But Frédéric Ducrozet, head of macroeconomic research at Pictet Wealth Management, said it was possible to take some positives from the situation. “It could have been a lot worse,” he said. For example, Germany's recession may have deepened significantly, he added. “Inflation was a disaster,” he said. “We're not in control, but we're moving in the right direction.”
He expects the central bank to start cutting interest rates in June, with a total cut of 1 percentage point by the end of the year. Other economists, including Goldman Sachs and Deutsche Bank, expect rate cuts to begin in April.
While there is debate over how quickly and if interest rates will be lowered, most economists agree that ultra-low interest rates are a thing of the past.
“The very low interest rates seen before the pandemic are unlikely to return, especially as the need to borrow money to invest in renewable energy and new technologies is much greater,” said Oxford Economics' Rakau. This is because the
