ECB slowing moving closer to rate cuts

At today’s press conference, ECB President Lagarde noted for the first time a stabilization of wage growth.

Dr Jörg Krämer

Commerzbank Economic Research

January 26 2024

In this respect, she took a small step towards interest rate cuts. Otherwise, however, the Governing Council maintained its view that it is premature to discuss rate cuts. We continue to expect the first rate cut only in June, followed by two further cuts of 25 basis points each in the second half of the year. We see significantly fewer rate cuts than the futures markets because we do not believe that the inflation problem has been solved.

As expected, the ECB's communiqué reiterated the key messages of mid-December. It sees key interest rates at a level that, if "maintained for a sufficiently long duration", will contribute significantly to the return of inflation to the 2% target. Policy rates will be set at "sufficiently restrictive levels for as long as necessary". During the press conference, President Lagarde said that there was a consensus in the Governing Council that it was "premature" to discuss rate cuts. However, unlike in December, she said there were signs that wage growth was stabilizing. In addition, corporate profit margins, which had recently helped to push up inflation, were coming under some pressure. All in all, the ECB took a small step towards rate cuts today, although Lagarde stressed that inflationary pressures would need to ease considerably more before the ECB could be confident of achieving its inflation target on a sustained basis.

First rate cut not until June

We continue to believe that the ECB will deliver a first rate cut only in June. This is because the data on first-quarter wage settlements will not be available until then and can be incorporated into the ECB's new inflation forecasts, which will be published in June. We expect further rate cuts of 25 basis points each in both September and December. We see significantly fewer rate cuts than the futures markets because we do not believe the inflation problem has been solved.

Wage increases still too strong

The ECB's continued caution in cutting interest rates is appropriate. This is because the main domestic cost factor, wages, is rising much faster than is compatible with the ECB's inflation target. The increase in collectively agreed wages in the euro area has accelerated to almost 5% (Chart 1). Wage pressures are likely to remain high. This is because workers have a lot of catching up to do. After all, per capita wages have been rising much more slowly than consumer prices since the end of 2000. In any case, the record-low unemployment rate puts them in a good position in negotiations with employers.

The 1970s call for caution

After the energy price shocks of the 1970s, inflation in many countries fell as rapidly as it has recently. However, according to a study by the International Monetary Fund, in almost half of the 100 cases analyzed, the inflation problem was not solved. Instead, inflation stabilized at rates that were significantly higher than before the respective inflation shocks, or even rose again. This was often because the central banks were blinded by the initial successes in the fight against inflation and did not stick to restrictive monetary policy long enough.