The president of the European Central Bank (ECB), Christine Lagarde, turned to Lithuanian poetry this Monday – specifically the book ‘The Seasons’, by Kristijonas Donelaitis – to ensure that the institution “is advancing in its monetary policy cycle, and “We are now at a stage where the darkest days of winter seem to be behind us and we can begin to look forward.”
Just four days after announcing the fourth drop of 0.25 points in official interest rates in the eurozone – to 3% – Lagarde has pronounced a speech in Vilniusheadquarters of the Bank of Lithuania, in which he has assured that the ECB is confident in the moderation of inflation to the theoretical objective of 2% in 2025 and that, if there are no surprises, it will continue to lower the ‘price’ of reference money to mortgages and loans in general during the coming months.
What remains unclear is to what extent. At last Thursday’s press conference, he cited the range of 2.5% to 1.75% – it is stated at the end of the official transcript, in this link—. This same Monday, in another speech in Madrid, the vice president of the ECB, Luis de Guindos, once again pointed out this range, but without giving more details. A few hours later, the representative of Germany on the organization’s executive committee, Isabel Schnabel, spoke of 1.5% to 3%, in this link. Since mid-November, Goldman Sachs and other ‘strong’ hands in the financial markets have been targeting the lower part of that range.
Lagarde has pointed out that past shocks—the bottlenecks in global trade due to the end of the pandemic, the energy crisis…—“dissipate” and are no longer transmitted to prices. “The risks to the inflation outlook have changed and, crucially, those risks are now more related to possible future shocks than to the transmission of past ones,” he explained.
“Since September of last year, we have had six consecutive rounds of forecasts that show that inflation will return to the target during 2025. And this arrival date has remained constant even as we have gotten closer to it,” he stressed. .
Furthermore, the president of the ECB admits the stagnation of economic growth in the eurozone – where Spain is a positive exception. The weakness of activity growth, especially in Germany and France, has become its greatest concern, despite the fact that it is not its main mandate, which is price stability.
Growth prospects are “weaker than expected” and, it continues, there is “increased uncertainty around growth caused by geopolitical developments.”
“For some time now, we have been seeing small downward revisions to the growth outlook which, taken together, have amounted to a fairly significant downgrade over time. For example, if we go back to our June 2023 projections, we expected average growth of 1.8% in 2024 [en el conjunto de la eurozona]. Now, we expect 0.7%,” he lamented.
It must be remembered that with last Thursday’s decisionthe institution continues to reverse the monetary austerity that it began to implement in 2022 to, precisely, suffocate the demand of families and the ability of companies to invest, and thus fight inflation.
Weakness in business investment and household consumption
One factor that has contributed to the stagnation of the European economy “has been the slow growth of exports, driven by the competitive challenges faced by eurozone companies.” But “the most important factor that has contributed to our growth forecasts not being met has been the internal economy. In fact, around half of the defaults since the end of 2021 are related to investment and a quarter to consumption,” Lagarde detailed.
The investment behavior can be attributed to a combination of reasons, “including the stronger than expected impact of higher interest rates, higher energy prices and structural deterrents. The inertia of consumption has been surprising, given that the conditions are in place for a recovery. “Employment is historically high and real incomes are increasing, but households continue to save an unusually high proportion of their income and adopt a cautious attitude when it comes to spending,” he reflected.
One reason for this caution is that many households have a perception of their real income growth that is far below the measured data. “Only 37% of households participating in our consumer survey believe their real income has increased or stayed the same, even though 50% of all households have experienced real increases. And these households have significantly lower consumption growth than those with correct perceptions,” observed the president of the ECB.
“This pessimism about real incomes is largely driven by past inflation, and so should in principle dissipate as the high inflation episode becomes further behind us. But growing geopolitical uncertainty could create new damage to household sentiment,” Lagarde continued.
According to his analysis, in particular, if the United States – our largest export market – adopts a protectionist stance, eurozone growth is likely to suffer.
Finally, “the main upside risks [para la inflación] that we see in the future are also related to external shocks. An increase in geopolitical tensions could drive up energy prices and transportation costs in the short term, while extreme weather events could drive up food prices. The net effect of trade fragmentation and tariffs on inflation remains uncertain, as it involves assumptions that are impossible to accurately anticipate. These include possible retaliatory actions, as well as movements in exchange rates and commodity prices.”
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