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European Central Bank president Christine Lagarde said rapid wage growth was already showing signs of slowing in the eurozone, striking a dovish note on the potential for interest rate cuts even as the central bank kept monetary policy on hold.
“The disinflation process is at work,” the central banker said at a press conference after the ECB kept its key interest rate on hold at a record high of 4 per cent and signalled inflation was falling in line with its expectations.
Lagarde said that the pick-up in inflation in December had been “weaker than expected” and forecast that price pressures would “ease further over the course of the year”.
While the ECB president warned that rapid wage growth and lower productivity were “keeping price pressures high”, she said there had already been a “slight decline” in wage growth that was “directionally good from our perspective”.
Lagarde outlined both upside and downside risks to inflation, but said that it could “fall faster than forecast in the short term” if energy prices continued to drop in line with lower market expectations for oil and gas prices.
The ECB was observing the disruption caused by the conflict in the Middle East “very carefully”, Lagarde said. “Shipping costs are increasing and delivery delays are increasing,” she said, adding this was “an additional risk” for the economy.
The euro fell slightly as Lagarde spoke, slipping 0.1 per cent against the dollar to $1.0871.
Investors have been watching for clues from central bankers on how fast inflation is likely to fall and when borrowing costs could start to be lowered.
“We will see interest rate cuts over the course of the year, but I don’t think the markets are correctly assessing the timing and extent,” Jörg Asmussen, a former ECB board member and current head of Germany’s insurance association, wrote on social media site X.
Economists have been cutting their forecasts for eurozone growth and inflation this year after weak data on industrial production, producer prices, business orders and retail sales pointed to a slowing economy.
Yet analysts still worry high wage growth and supply chain disruption caused by attacks on ships in the Red Sea could keep inflation high.
Western central banks are becoming more confident they could soon start cutting interest rates as inflation falls closer to their targets. But they are weighing the risk of a resurgence in price pressures if they lower borrowing costs too soon against the danger of doing unnecessary damage to growth and jobs by waiting longer than needed.
Central banks in Japan, Canada and Norway have also left policy unchanged this week, with similar outcomes expected from the US Federal Reserve and the Bank of England next week.
The ECB predicted last month that inflation would slowly drop to its 2 per cent target by mid-2025 and Lagarde said last week that a rate cut “is likely” by the summer. But price growth has undershot the bank’s forecasts for the last couple of months, leading investors to bet this trend will prompt it to start cutting rates as early as April.
The gloomy outlook for the eurozone economy was underlined by the Ifo Institute’s closely watched survey of German businesses, whose business climate index showed an unexpected fall in its business climate index by 1.1 points to 85.2, its lowest level since May 2020. Economists polled by Reuters had forecast a jump in business confidence would lift the index to 86.7.
Eurozone inflation has dropped steadily from a peak of 10.6 per cent in late 2022 to 2.4 per cent in November. But in December it picked up to 2.9 per cent due to the phasing out of energy subsidies.
Core inflation, which excludes more volatile energy and food costs to give a better idea of underlying price pressures, has been stickier at 3.4 per cent in December.
Additional reporting by Mary McDougall
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