The European Central Bank kept its key interest rate at a record high on Thursday and is now facing expectations it will start cutting borrowing costs next year to support the shrinking economy.
It follows similar decisions this week by the US Federal Reserve, Bank of England and Swiss National Bank to leave rates unchanged. The Fed also signalled it could make three interest rate cuts next year.
The ECB said it’s keeping its benchmark rate at 4 per cent because inflation was “likely to pick up again temporarily in the near term.”
Central banks around the world drastically raised rates to contain inflation that broke out in the wake of the Covid-19 pandemic and Russia’s invasion of Ukraine. They’re now trying to balance keeping rates high enough for long enough to make sure inflation is contained against the risk that higher borrowing costs could throw their economies into recession.
Inflation has fallen more than expected in the 20 European Union countries that use the euro currency, to 2.4 per cent in November from a peak of 10.6 per cent in October 2022. That’s not too far from the ECB’s goal of 2 per cent considered best for the economy.
That has led analysts to predict the ECB will cut rates next year, though the timing is not certain and forecasts range from March to September for the move. The bank’s key rate stands at an all-time high of 4 per cent.
ECB President Christine Lagarde will lay out her view of the economy at a news conference that will be closely watched for any signals about rate cuts. Lagarde, however, has said the bank will make decisions based on the latest information about how the economy is doing.
While inflation is down following a record pace of rate hikes, economic growth has lagged because the cost of borrowing has surged for things like home purchases and business investment in new offices and factory equipment. The eurozone saw economic output shrink 0.1 per cent in the July-to-September quarter.
Meanwhile, wages are still catching up to higher prices in shops, leaving European consumers less than euphoric even as European city centrrs deck themselves in Christmas lights.
In Paris, travel agent Amel Zemani says Christmas shopping will have to wait for the post-holiday sales.
“I can’t go shopping this year, I can’t afford Christmas gifts for the kids,” she said. “What do they want? They want sneakers. I’m waiting for the sales to give them the gifts then. And they understand.”
Steven Ekerovich, an American photographer living in the French capital, said that while “Paris was lagging easily 50 per cent behind the rest of the major cosmopolitan cities in pricing, it’s catching up fast. Rents, food, clothing. So, you have got to be careful now.”
Europe’s falling inflation and economic stagnation — output declined 0.1 per cent in the July-to-September quarter — mean the ECB may be the first major central bank to pivot to rate cuts, said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.
But the expectations vary, from Deutsche Bank’s prediction that March is a possibility to Pictet’s view that June is most likely. Lagarde has emphasised that decisions will be made based on the latest information about how the economy is doing.
“It remains to be seen how strong Lagarde will be able to push back against market pricing. She is more likely to stress the ECB’s data dependence, refraining from committing to any specific sequencing,” Ducrozet said in a research note.
Expectations of a March rate cut may be “excessive euphoria,” said Holger Schmieding, chief economist at Berenberg bank, cautioning that inflation could rise again before falling further. He doesn’t see a rate cut before September.
Higher interest rates combat inflation by increasing the cost of borrowing throughout the economy, from bank loans and lines of credit for businesses to mortgages and credit cards. That makes it more expensive to borrow to buy things or invest, lowering demand for goods and easing prices.
Facing an energy crisis that fuelled record inflation, the ECB raised its benchmark rate from below zero to an all-time high of 4 per cent between July 2022 and this July.
But higher rates also have held back economic growth. For example, apartment construction projects are being cancelled across Germany, the biggest European economy, because they no longer make business sense amid higher interest costs.