Wanted: the right time to cut key interest rates – Economy

There has been speculation for many weeks now about when the European Central Bank will cut its key interest rate for the first time. The responsible central bankers in the ECB Council are divided and in their public statements follow a “it depends” line of argument that sometimes tends in one direction and sometimes in the other. The whole thing can be seen as an expression of great uncertainty, because in the end the start and number of interest rate cuts will be determined by the “inflation depend,” as ECB chief economist Philip Lane recently put it with disarming logic.

Inflation has now fallen significantly. In January the value for the euro zone was 2.8 percent. That is slightly less than in December, but is still well above the monetary authorities’ target. The central bank wants to achieve exactly two percent inflation for Europe’s economy in the medium term.

ECB President Christine Lagarde is therefore warning against a hasty interest rate cut. “The last thing I want is for us to make a hasty decision only to see inflation rise again and have to take further measures,” Lagarde told the European Parliament’s Economic and Monetary Affairs Committee on Thursday. The central bank needs even more data. She will continue to proceed based on data and make decisions from meeting to meeting.

The monetary authorities have raised interest rates ten times in a row since July 2022, most recently in September 2023. Since then, the main refinancing rate at which banks can obtain fresh money from the central bank has been 4.5 percent. The so-called deposit rate, with which the central bank pays interest on surplus funds from commercial banks, is at four percent – this is the highest level in the history of the monetary union.

The high key interest rates are having an effect. Banks are granting fewer loans, companies and consumers are shying away from high interest costs. The real estate markets have cooled noticeably, especially in the commercial sector. Germany is suffering the most economically, but growth prospects in the Eurozone as a whole are also rather poor. It is therefore not surprising that calls for a reduction in key interest rates are becoming louder and louder. In politics, in the economy, but also among central bankers.

For ECB Council member Fabio Panetta, the time “for a reversal of the monetary policy course is fast approaching”. His Portuguese colleague Mario Centeno explains the reason: “We cannot have an economy that does not grow, that is my main concern for Europe.”

The fear of the wage-price spiral

However, the express aim of the tight interest rate policy is to cool down the economy. The thinking goes that the declining demand reduces price pressure. The question is how much the economy should be cooled down in order to rule out a resurgence of high inflation rates. The concern: Because unemployment in Europe is lower than ever and unions are pushing through high wages, a wage-price spiral could develop. That would mean: Companies add labor costs to prices, which in turn triggers new wage demands.

Wage growth is not in line with the inflation target ECB of two percent, says the head of the Belgian central bank, Pierre Wunsch. “Without the strong wage increases, the easing of monetary policy could already begin.” ECB Director Isabel Schnabel warned in an interview with the Financial Times “Patience and caution” on interest rate policy given stubborn inflation in the services sector, a robust labor market and geopolitical tensions on the Red Sea.

The next ECB interest rate meeting is on March 7th, and the experts believe that the interest rate screw will not be turned. The financial markets believe that the first interest rate cut in April is possible. Others are looking ahead to the June meeting, when key pay data will be available. In the end, unsurprisingly, it will depend on inflation.