The European Central Bank has left its key interest rate at a record high as it waits for more confirmation that toxic inflation is under control for good – even as high borrowing costs drag on the stalled economy.
The decision comes as central banks around the world, including the US Federal Reserve, are trying to judge whether inflation has been tamed to the point that they can start cutting rates – making it cheaper for consumers and businesses to borrow, spend and invest – and avoid an economic slowdown that throws people out of their jobs.
Market predictions for a European Central Bank (ECB) rate cut as soon as April have faded, and expectations among analysts have shifted towards a first trim in June.
ECB president Christine Lagarde’s press conference on Thursday will be closely watched for clues on when cuts might begin.
With recent economic data, “the pressure on the ECB to cut rates earlier has gone up”, Carsten Brzeski, chief of global macro at ING bank, wrote in an analyst note. “We still think that the ECB has good reasons to resist that pressure and to push back expectations.”
The ECB raised its key rate from below zero to 4 per cent between July 2022 and September 2023 to squash double-digit inflation driven by supply-chain issues during the rebound from the coronavirus pandemic and by an energy crisis after Russia invaded Ukraine.
Higher interest rates dampen inflation by making it more expensive to borrow and buy things on credit, reducing demand for goods. But high rates can weigh on economic growth, too.
The stalled economy has focused attention on when the ECB might start withdrawing some of its bitter anti-inflation medicine to avoid tipping Europe into an outright recession.
The 20 countries that use the euro currency saw no growth in the fourth quarter of last year after shrinking 0.1 per cent in the previous quarter. Germany, Europe’s largest economy, expects to grow just 0.2 per cent this year.
One reason the ECB can afford to wait on a cut: a strong jobs market that is keeping people in work and with paychecks to spend.
Unemployment of 6.4 per cent is the lowest since the euro currency was launched in 1999.
In that sense, economists say Europe’s economic sluggishness does not resemble a classic downturn and is due more to the external shock of losing cheap energy from Russia and a more general slowdown in world trade.
A similar situation is shaping up in the US, where Federal Reserve chair Jerome Powell told Congress this week that the central bank needed more confidence that inflation was under control before cutting rates.
Fed officials have signalled three rate cuts this year, but Mr Powell has given no indication when they might start.
In Europe, inflation was down to 2.6 per cent in February, well below its peak of 10.6 per cent in October 2022. But the consumer price index has been stuck between 2% and 3% for five months, raising concern that the last mile towards the ECB’s goal may be slower than hoped.
While the spikes in food and energy prices that helped drive the outbreak of inflation have eased, inflation has spread to services, a broad sector of the economy that includes everything from film tickets and office cleaning to tuition and medical care.
Meanwhile, wages rose as workers started bargaining for higher pay to make up for lost purchasing power as inflation ballooned.
