Hawkish policymakers at the European Central Bank have been emboldened to resist calls for an imminent cut to interest rates at their meeting this week after inflation proved stickier than expected in February.
Until a few months ago, investors were betting the ECB would cut borrowing costs as early as this month, encouraged by how swiftly eurozone inflation has fallen from its peak above 10 per cent to below 3 per cent.
However, those expectations have faded in recent weeks, as ECB policymakers signalled they were in no rush to loosen monetary policy despite the swift easing of consumer price rises and continued stagnation in the eurozone economy.
Friday’s release of inflation data for the single currency bloc, showing it fell less than expected from 2.8 per cent in January to 2.6 per cent in February, has reinforced the determination of the ECB’s more hawkish rate-setters to resist pressure for rate cuts.
“We watched inflation data coming in from [the] European and country level, and what we see is that they confirm my view that we have to wait, have to be attentive and cannot rush to a decision,” Austria’s hawkish central bank chief Robert Holzmann said on Friday.
Even some of the more dovish rate-setters seem reconciled to a wait-and-see approach on lowering borrowing costs, underlined by Greek central bank governor Yannis Stournaras’s comment last week that such a move should come “no later than June”.
Economists pointed to persistently high services inflation as the key factor making rate-setters nervous about the risk of cutting rates too soon. Eurozone services prices rose 3.9 per cent in February, only a slight dip from consecutive 4 per cent rises in each of the previous three months.
This “sticky” services inflation figure “will embolden the many members of the governing council that are calling for patience, making any rate cut before June highly unlikely”, said Marco Valli, chief European economist at Italian bank UniCredit.
Tomasz Wieladek, an economist at investor T Rowe Price, said it was a “very worrying sign” that eurozone inflation picked up on a month-on-month basis to 0.6 per cent in February, the fastest pace since last April.
Last week’s data prompted several analysts, including those at Barclays and Goldman Sachs, to delay their forecasts of when the ECB will start cutting rates from April to June.
Recent hotter than expected US inflation data and more hawkish signals from the US Federal Reserve could also give ECB rate-setters more confidence to take their time on rate cuts.
The ECB will want to “minimise the risk of being caught on the wrong foot by an upward surprise in inflation, all the more as the Fed became more hawkish as of late”, said Martin Wolburg, economist at Italy’s Generali Investments.
ECB policymakers are this week expected to reiterate their concern that rapid wage growth may keep prices rising too fast in the labour-intensive services sector, which is especially important as it accounts for 45 per cent of all prices used to calculate inflation.
Annual rises in collectively negotiated wages, which cover the majority of eurozone workers, slowed from a record high of 4.7 per cent in the third quarter to 4.5 per cent in the fourth quarter of last year. But that is still well above the 3 per cent level the ECB says is needed for inflation to hit its 2 per cent target.
The strength of the region’s labour market, with unemployment remaining at a record low of 6.4 per cent in January, is a pivotal factor behind the ECB’s patient approach to easing monetary policy, after it raised its main policy rate to an all-time high of 4 per cent last year.
“The key to all this is the continued resilience in the labour market,” said Katharine Neiss, chief European economist at investor PGIM Fixed Income. “Any whiff that this is deteriorating sharply, with rising unemployment and the prospect for insolvencies, would prompt the ECB to be proactive in cutting not only early but aggressively.”
Some European politicians are, however, already calling for the ECB to do more to support the euro area’s struggling economy, which flatlined in the fourth quarter after stagnating for much of last year. The Italian and Portuguese finance ministers both appealed for a swift reduction in borrowing costs during last week’s G20 meetings in São Paulo.
The central bank is widely expected to cut its growth and inflation forecasts while keeping rates unchanged at its meeting on Thursday. This could intensify fears in some quarters that it is squeezing the economy more than needed to tame price pressures, especially after eurozone bank lending to businesses and households declined in January.
“The conditions are there for a cut now,” said Annalisa Piazza, a fixed income research analyst at MFS Investment Management. “But I expect the ECB will keep stressing the need to see more wage data, which I don’t think is really necessary.”
Yet despite widespread gloom about economic weakness in much of Europe, particularly in Germany, there have also been some signs of a nascent rebound in activity that hawkish ECB policymakers are likely to seize on as further proof they should not rush into loosening monetary policy.
These faint green shoots include an upgrade to fourth-quarter gross domestic product estimates for both France and Italy that suggest the overall eurozone growth figure may get revised upward into positive territory.
Having been widely criticised for being too slow to start raising rates in response to the biggest surge in inflation for a generation in 2022, the ECB now seems determined to take its time before loosening policy to avoid being in the line of fire once more.
“To some extent, the fact that they underestimated the inflation surge means that they will now stick to the tightening bias,” said Carsten Brzeski, an economist at Dutch bank ING.
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