European Central Bank (ECB) policymakers have been poised to opt against another interest rate hike for the first time in over a year. The decision comes as once-soaring inflation, triggered by Russia’s invasion of Ukraine in early 2022, shows signs of abating, coupled with a gloomier economic outlook.
Consumer prices within the 20-nation currency bloc increased at an annual rate of 4.3 percent in September, marking the lowest point in almost two years. Although this figure remains above the ECB’s two-percent target, the repercussions of escalating interest rates are increasingly palpable across the region.
The recent outbreak of the Israel-Gaza conflict further exacerbates the challenges faced by the eurozone economy, which is already grappling with the fallout from the Ukrainian crisis.
Following cues from the US Federal Reserve, the central bank seems set to temporarily halt interest rate hikes. As Jack Allen-Reynolds from Capital Economics noted, all signs since the last meeting in September suggest that the ECB’s current tightening cycle has come to an end.
Currently, the ECB’s key deposit rate stands at four percent, the highest in the bank’s history. However, after raising rates at each of the last 10 meetings at an unprecedented pace, analysts like Carsten Brzeski from ING bank believe that the ECB won’t rush into further actions.
The Middle East conflict, combined with soaring oil prices, has placed the ECB in a more “complex” situation, according to Brzeski, who added, “With all the new uncertainties, there hasn’t been a better moment in the last 16 months for the ECB to take a pause than now.”
Several eurozone governments, including Italy and Portugal, have expressed criticism of the ECB’s aggressive rate hikes, while enthusiasm for further increases has waned among the 26 members of the ECB’s governing council.
The slowdown in eurozone inflation has led to French central bank governor Francois Villeroy de Galhau stating that “our current benchmark rates are appropriate.”
ECB President Christine Lagarde acknowledges the “pain” experienced by households due to aggressive rate hikes but cautions against relenting too soon. Allen-Reynolds suggests that her emphasis will likely be on keeping monetary policy tight for an “extended period.”
Luis de Guindos, another member of the ECB’s board, warns that taming inflation will be a time-consuming process, with high inflation expected to persist for a while. As of the ECB’s September projections, inflation is not anticipated to return to the two-percent target before 2025.
The governing council will revisit the question of rate hikes at its year-end meeting in December, armed with new forecasts. Brzeski highlights the possibility of further economic challenges in the eurozone before then.
Recent economic indicators have shown a downward trend, with Germany sinking deeper into recession. The International Monetary Fund downgraded its forecast for Germany earlier this month, projecting a 0.5-percent shrinkage for Europe’s largest economy in 2023, with the eurozone as a whole struggling to achieve 0.7-percent growth.
In the meantime, the ECB aims to maintain a determined stance while keeping the door open for another rate hike in December, says Brzeski. A decision to keep rates unchanged this week could be presented as a temporary “pause” but might evolve into a more extended plateau, adds Allen-Reynolds, while interest rate cuts remain a distant possibility.
