The de-escalation of interest rates is taking shape. The European Central Bank approved this Thursday a new cut of 25 basis points in the price of money, the second so far this year, in an exercise of confidence that inflation, that long headache that has lasted for three years, is increasingly under control.[Ante] Given the dynamics of underlying inflation and the intensity of monetary policy transmission, it is now appropriate to take a further step in moderating the degree of restriction,” said the president of the entity, Christine Lagarde, on Thursday.
This is just the beginning: the markets had already discounted this decision, so after the announcement, the stock markets and the euro barely flinched. Investors expect, at the very least, one more drop this 2024 and several next year, in a return to more normal rates after the swings of recent times, when there has been a shift, with hardly any transition, from the negative rates of the pandemic to a historic increase to contain runaway inflation due to the economic rebound that followed the virus. With the ECB’s decision, the deposit facility, the reference rate, remains at 3.5%. While the rate on the main refinancing operations falls to 3.65% and the marginal lending rate to 3.90% as a technical adjustment is implemented that reduces both indicators by an additional 35 basis points.
In addition to the monetary policy decision, the ECB experts have also updated their inflation forecasts. No major changes: they expect headline inflation to average 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026, exactly the same as in the June projections. “Recent inflation data have been, overall, in line with expectations,” they explain. They do slightly revise upwards (by one tenth) the underlying inflation for 2024 and 2025, which will be 2.9% and 2.3% respectively, something they attribute to the impact of services inflation, “higher than expected.”
The return to normality will be bumpy. Lagarde expects inflation to “rise again in the final stretch of this year” because energy prices will no longer compare favourably with those of last year. However, the expected dip is not a threat: “inflation should ease towards our target in the second half of next year,” Lagarde predicts.
As for growth, the news is not so favourable: they project a rate of 0.8% in 2024, which will progressively increase to 1.3% in 2025 and 1.5% in 2026, a slight downward revision compared to June, of one tenth each year, due to a lower contribution from domestic demand. “Financing conditions remain restrictive, and economic activity is still contained, reflecting the weakness of private consumption and investment,” notes the ECB.
All eyes are now on the press conference of the president of the institution, Christine Lagarde, starting at 2:45 p.m., in case she offers any clues about the next moves. Most analysts are discounting a new cut at the meeting on December 12, but there are more doubts about what will happen before then, at the October meeting, where a pause is not ruled out, but also another slight discount of a quarter of a point. External variables will come into play there, such as the magnitude of the first rate cut since 2020 by her American counterpart, Jerome Powell, at the Fed meeting on September 18. “A larger-than-expected cut by the Federal Reserve may increase the pressure for the ECB to do more than is currently discounted,” says Nadia Gharbi, European economist at Pictet.
If the rate cut in June had a certain aroma of a change of cycle, being the first in five years, this September is one of continuity, of consolidating a new course that already seems immovable in the medium term, certifying the end of the Frankfurt recipe for pain: ten uninterrupted rate hikes to combat inflation that reached over 10% in October 2022, its historical maximum.
At that time of maximum tension, the Eurobank’s managers would surely have signed up to where they are today: inflation has fallen to levels very close to their 2% target, moderating to 2.2% in August – four-tenths less than in July, and three-tenths below that of the United States -, pushed by the fall in the prices of gas, oil and fresh food. And although growth is showing signs of fatigue – with Germany stagnating – high rates, which have restricted access to financing and increased the bills of indebted households and companies, which tends to cool consumption, have not generated a wide-ranging recession, as feared.
Nor have they caused turbulence in the markets, with some of the main European stock markets close to their highest levels and the euro gaining ground against the dollar, making imports cheaper. Only inflation in services, stickier than expected, has not fallen as expected (it was 4.2% in August, two-tenths more than in July).
The good performance of the labour market has kept growth at positive, albeit anaemic, rates: the unemployment rate, at 6.4%, is the lowest since the euro was created. And for now it has done so in a clean manner, without any unpleasant collateral effects: wage increases have shown signs of slowing down in the second quarter, dispelling the spectre of the dangerous price-wage spiral, so often evoked by Lagarde. “Domestic inflation remains high, as wages continue to rise at a high rate. However, pressures on labour costs are moderating, and profits are partially cushioning the impact of wage increases on inflation,” the entity highlights in its communication.
The ECB president has made an enemy along the way: those with variable-rate mortgages. You only need to search for the names Lagarde and mortgage together on a social network to see that the rise in mortgage rates caused by the ECB’s tough interest rate policy has been a financial blow for many. But the relationship with her detractors seems to be improving: the Euribor is now below 3%, its lowest level in almost two years, and the role of aggrieved party is now played by conservative savers, who have seen how the returns they receive for buying Treasury bills continue to fall as expectations of interest rate cuts grow. The banks are also leaving their best days behind: the ECB vice-president, Luis de Guindos, believes that their profitability has already reached a peak, at the end of the cycle of interest rate increases that provide them with extra mortgage income.
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